M/s Omega Electronics Ltd. Exports air conditioners to germany by importing all the components from Singapore. The company is exporting 2,400 units at a price of Euro 500 per units. The cost of imported components is S$ 800 per unit. The fixed cost and other variables cost per unit are Rs. 1,000 and Rs. 1,500 respectively. The cash flow in foreign currencies are due in six months. The current exchange rates are as follows :-

Rs./Euro                51.50/55

Rs./$                      27.20/25

After 6 months the exchange rates turn out as follows :

Rs./Euro                52.00/05

Rs./$                      27.70/75

1. You are required to calculate loss/gain due to transaction exposure.
2. Based on the following additional information calculate the loss/gain due to transaction and operating exposure if the contracted price of air conditioners is Rs. 25,000 :
   1. The current exchange rate changes to :

Rs./Euro                    51.75/80

Rs./$                                    27.10/15

• Price elasticity of demand is estimated to be 1.5
  • Payments and Receipts are to be settled at the end of six months.

Solution

(a) Profit at current exchange rates

2400[€500×S$51.50– (S$800 ×Rs. 27.25 +Rs. 1,000+ Rs. 1,500)]

2400[Rs..25,750- Rs. 24,300] = Rs. 34,80,000

Profit after change in exchange rates

2400[€500× Rs. 52– (S$800× Rs. 27.75+ Rs. 1000+ Rs. 1500)]

2400[Rs. 26,000- Rs. 24,700] = Rs. 31,20,000 LOSS DUE TO TRANSACTION EXPOSURE Rs. 34,80,000– Rs. 31,20,000= Rs. 3,60,000

Profit based on new exchange rates

2400[Rs. 25,000-(800× Rs. 27.15+ Rs. 1,000+ Rs. 1,500)]

2400[Rs. 25,000 – Rs. 24,220]= Rs. 18,72,000

Profit after change in exchange rates at the end of six months 2400[Rs. 25,000-(800×Rs. 27.75+ Rs. 1,000+ Rs. 1,500)]

2400[Rs. 25,000- Rs. 24,700]= Rs. 7,20,000

Decline in profit due to transaction exposure

Rs. 18,72,000- Rs. 7,20,000 = Rs. 11,52,000

Current price of each unit in S$=25,000/51.50 =  S$ 485.44

Price after change in Exch. Rate= 25,000/51.75 = S$ 483.09

Change in Price due to change in Exch. Rate S$ 485.44-S$ 483.09 = S$ 2.35 or (-) 0.48%

Price elasticity of demand = 1.5

Increase in demand due to fall in price 0.48×1.5 =0.72% Size of increased order = 2400 ×1.0072 = 2417 units

Profit = 2417 [Rs. 25,000– (800 × Rs. 27.75 + Rs. 1,000 + Rs. 1,500)]

=2417[Rs. 25,000- Rs. 24,700]

= Rs. 7,25,100

Therefore, decrease in profit due to operating exposure

Rs. 18,72,000 – Rs. 7,25,100 = Rs.11,46,900

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