Case Study: ECONOMIC EXPOSURE OF ALBION COMPUTERS PLC Suppose a U.S. computer company has a wholly-owned British subsidi

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Case Study: ECONOMIC EXPOSURE OF ALBION COMPUTERS
PLC
Suppose a U.S. computer company has a wholly-owned British
subsidiary, Albion Computers PLC, which manufactures and sells
personal computers in the U.K. market. Albion Computers imports
microprocessors from Intel, which sells them for $512 per unit. At
the current exchange rate of $1.60 per pound, each Intel
microprocessor costs £320. Albion Computers hires British workers
and sources all the other inputs locally. Albion faces a 50 percent
income tax rate in the U.K.
The exhibit below summarizes projected operations for Albion
Computers, assuming that the exchange rate will remain unchanged at
$1.60 per pound. The company expects to sell 50,000 units of
personal computers per year at a selling price of £1,000 per unit.
The unit variable cost is £650, which comprises £320 for the
imported input and £330 for the locally sourced inputs. Needless to
say, the pound price of the imported input will change as the
exchange rate changes, which, in turn, can affect the selling price
in the U.K. market. Each year, Albion incurs fixed overhead costs
of £4 million for rents, property taxes, and the like, regardless
of output level. As the exhibit shows, the projected operating cash
flow is £7,250,000 per year, which is equivalent to $11,600,000 at
the current exchange rate of $1.60.
1. Now consider the possible effect of an appreciation of the
pound on the projected dollar operating cash flow of Albion
Computers. Assume that the pound may appreciate from $1.60 to $1.90
per pound.
(a) Suppose Albion decides to maintain its selling price of its
personal computers in the U.S. market at US$1,600 per unit. Compute
the projected cash flow in pounds as well as in dollars following
the pound appreciation.
(b) Assuming that the pound appreciation would affect CFs for 4
years, and assuming a discount rate of 15%, calculate the PV of the
CFs over 4 years. Using the benchmark case for comparison,
calculate Albion’s Gain/Loss in operating CFs from the change in
the pound.
2. Consider Case 3 of Albion Computers PLC discussed in the
chapter. Now, assume that the pound is expected to depreciate to
$1.50 from the current level of $1.60 per pound. Other variables,
such as the unit sales volume and the U.K. inflation rate of 8
percent, remain the same as in Case 3. Also, because of facing an
elastic demand for its products, sales volume declines to 40,000
units per year after the price increase. Sales price is $1080
(a) Compute the projected annual cash flow in pounds as well as
in dollars.
(b) Assuming that the pound depreciation would affect CFs for 4
years, and assuming a discount rate of 15%, compute the PV of the
CFs over 4 years. Using the benchmark case for comparison,
calculate Albion’s projected operating gains/losses over the
four-year horizon due to the pound depreciation.