Abc inc an exporting firm expects to earn 20 million

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Essentials of Economics
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Chapter 9 / Exercise 2
Essentials of Economics
Mankiw
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96) ABC Inc., an exporting firm, expects to earn $20 million if the dollar depreciates, but only $10 million if the dollar appreciates. Assume that the dollar has an equal chance of appreciating or depreciating. Calculate the expected tax of ABC if it is operating in a foreign country that has progressive corporate taxes as shown. Corporate income tax rate = 15% for the first $7,500,000. Corporate income tax rate = 30% for earnings exceeding $7,500,000.A) $3,375,000B) $6,000,000C) $1,500,000D) $4,500,000Answer: AExplanation: 0.5 [(0.15)( $7,500,000) + (0.30)($20,000,000 − $7,500,000)] + 0.5 [(0.15)($7,500,000) + (0.30)($10,000,000 − $7,500,000)] = $3,375,000.Topic: Should the Firm Hedge?Accessibility: Keyboard Navigation97) ABC Inc., an exporting firm, expects to earn $20 million if the dollar depreciates, but only $10 million if the dollar appreciates. Assume that the dollar has an equal chance of appreciating or depreciating. Step one: calculate the expected tax of ABC if it is operating in a foreign countrythat has progressive corporate taxes as shown.Corporate income tax rate = 15% for the first $7,500,000.Corporate income tax rate = 30% for earnings exceeding $7,500,000.Step two: ABC is considering implementing a hedging program that will eliminate their exchange rate risk: they will make a certain $15 million whether or not the dollar appreciates or depreciates. How much will they save in taxes if they implement the program?A) $0B) $3,375,000C) $1,500,000D) $4,500,000Answer: AExplanation: First, determine the tax if ABC Inc. doesn't implement the hedging program: 0.5 [(0.15)( $7,500,000) + (0.30)($20,000,000 − $7,500,000)] + 0.5 [(0.15)($7,500,000) + (0.30)($10,000,000 − $7,500,000)] = $3,375,000. Now, determine the tax if BAC Inc. does implement the hedging program: ($7,500,000) (0.15) + ($15,000,000 − $7,500,000)(.30) = $3,375,000. There is $0 difference between the two strategies.Topic: Should the Firm Hedge?Accessibility: Keyboard Navigation
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Essentials of Economics
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Chapter 9 / Exercise 2
Essentials of Economics
Mankiw
Expert Verified
98) A study of Fortune 500firms hedging practices shows thatA) over 90 percent of Fortune 500firms use forward contracts.B) over 90 percent of Fortune 500firms use options contracts.C) over 90 percent of Fortune 500firms use both forward and options contracts.D) none of the optionsAnswer: ATopic: What Risk Management Products Do Firms Use?Accessibility: Keyboard Navigation99) If default costs are significant,A) corporate hedging would be justifiable because it will reduce the probability of default.B) corporate hedging would be unjustifiable because it will increase the probability of default.C) corporate hedging would be unjustifiable because it will increase the probability of default, resulting in a decreased credit rating and higher financing costs.D) none of the optionsAnswer: ATopic: Should the Firm Hedge?Accessibility: Keyboard Navigation100) With respect to information asymmetry,A) management knows about the firm's exposure position much better than stockholders, and therefore should be the ones to manage exchange exposure.B) stockholders know about the firm's exposure position much better than management, and therefore should be the ones to manage exchange exposure.C) regulators know about the firm's exposure position much better than management, and therefore should be the ones to oversee exchange exposure.D) none of the optionsAnswer: ATopic: Should the Firm Hedge?Accessibility: Keyboard Navigation

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