Develop a hedging strategy for the norwegian firm

Reference no: EM132172414

Question - A Norwegian company sells its famous snow shoes in Canada. It has developed a sensitivity analysis for next year's sales to identify its economic exposure with respect to the Canadian dollar (CAD). Here are the projections of its sales in Canada. Every state is considered to occur equally likely.

	State 1	State 2	State 3	State 4	State 5
S(CAD/NOK)	0.2857	0.2500	0.2222	0.2000	0.1818
Units sold (in 1000)	16.2	17.9	20	17.9	16.2
Price per unit (CAD)	142.86	125.00	111.11	100	90.91
Sales (in 1000 CAD)	2314.286	2237.5	2222.22	1790.00	1472.73

And the projections of its costs which are incurred in NOK:

	State 1	State 2	State 3	State 4	State 5
Unit Cost (NOK)	200	200	200	200	200
Fixed Costs (in 1000 NOK)	4100	4100	4100	4100	4100
Depreciation (in 1000 NOK)	700	700	700	700	700

a. Calculate the free cash flow in NOK-terms for the different states. The corporate tax rate is 30%.

b. Visualize the economic exposure that is plot the free cash flow in relation to the exchange rate How would you describe this exposure?

c. Develop a hedging strategy for the Norwegian firm that reduces the economic exposure as much as possible. In particular, which financial contract would you advise the firm to buy, what are the contract details, and in which amount. For simplicity assume that all cash flows accrue at the end of the year

d. Calculate the total cash flow to the firm (original free cash flow plus payoff from the hedging instrument chosen) if it uses your hedging strategy. (Don't consider the cost of your hedging strategy.).

Reference no: EM132172414

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