Answer to Question #158960 in Economics for H

Question

A South African company has a wholly owned subsidiary, Puleng (Pvt) Ltd, that manufactures and sells

printers in the Botswana market. Puleng (Pvt) Ltd imports printer cartridges from B2B, which sells them

for R512 per unit. At the current exchange rate of R1.60 per Pula, each B2B printer cartridge costs

P320. Puleng (Pvt) Ltd hires Botswana workers and sources all other inputs locally. Puleng (Pvt) Ltd

faces a 50% income tax rate in Botswana.

Exhibit 1 summarises projected operations for Puleng (Pvt) Ltd printers, assuming that the exchange

rate will remain unchanged at R1.60 per Pula. The company expects to sell 50 000 units of printers per

year at a selling price of P1 000 per unit. The unit variable cost is P650, which comprises P320 for the

imported unit and P330 for the locally sourced inputs. Needless to say, the Pula price of the imported

unit will change as the exchange rate changes, which, in turn can affect the selling price in the Botswana

market. Each year, Puleng (Pvt) Ltd incurs fixed overhead costs of P4 million for rents, property taxes,

and the like, regardless of output level. As Exhibit 1 shows, the projected cash flow is P7 250 000 per

year, which is equivalent to R11 600 000 at the current exchange rate of R1.60 per pound.

Exhibit 1 Projected Operations of Puleng (Pvt) Ltd Benchmark Case: (R1.60/P)

Sales (50 000 units at P1 000/unit) P50 000 000

Variable Costs (50 000 units at P650/unit) 32 500 000

Fixed Overhead costs 4 000 000

Depreciation allowances 1 000 000

_________

Net Profit Before Tax P12 500 000

Income Tax (at 50%) 6 250 000

Profit after Tax 6 250 000

Add back depreciation 1 000 000

_________

Operating cash flows R 7 250 000

Operating cash flows P 11 600 000

Exhibit 2 Projected Operations of Puleng (Pvt) Ltd (R1.40/P)

Sales (40 000 units at P1 080/unit) P43 200 000

Variable Costs (40 000 units at P722/unit) 28 880 000

Fixed Overhead costs 4 000 000

Depreciation allowances 1 000 000

_________

Net Profit Before Tax P9 320 000

Income Tax (at 50%) 4 660 000

Profit after Tax 4 660 000

Add back depreciation 1 000 000

_________

Operating cash flows R 5 660 000

Operating cash flows P 7 924 000

CONFIDENTIAL FIN4802

Page 14 of 20 January/February 2021 (Non Venue Based)

Exhibit 3 Summary of Operating exposure Effect of Pula depreciation on Puleng (Pvt) Ltd

Variables Benchmark Case Case 1 Case 2 Case 3

Exchange Rate (R/P) 1.60 1.40 1.40 1.40

Unit Variable cost (P) 650 696 696 722

Unit Sales Price (P) 1 000 1,000 1 143 1 080

Sales Volume (units) 50 000 50 000 50 000 40 000

Annual Cash flow (R) 7 250 000 6 100 000 9 675 000 5 660 000

Annual cash flow (P) 11 600 000 8 540 000 13 545 000 7 924 000

4 –year present value (R)a 33 118 000 24 382 000 38 671 000 22 623 000

Operating gains/loss (R)b -8 736 000 5 553 000 -10 495 000

a- The discounted present value of rand cash flows was computed over a four-year period using a 15% discount rate. A constant

cash flow is assumed for each of four years.

b- Operating gains or losses represent the present value of change in cash flows, which is due to Pula depreciation, from the

benchmark case.

Exhibit 3 summarises the projected operating exposure effect of the Pula depreciation on Puleng (Pvt)

Ltd. For expositional purposes it is assumed here that a change in exchange rate will have effect on the

firm’s operating cash flow for four years. Exhibit 3 provides, among other things, the four-year present

values of operating cash flows (over a four-year period) for the benchmark case that are due to the

exchange rate change. In Exhibit 2, for instance, the firm expects to experience an operating loss of

R10 495 000 due to the Pula depreciation.

Consider Exhibit 2 of Puleng (Pvt) Ltd. Now, assume that the Pula is expected to depreciate to R1.50

per Pula from the current level of R1.60 per Pula. This implies that the Pula cost of the imported part,

i.e. B2B’s printer cartridges, is P341 (=R512/R1.50). Other variables, such as the unit sales volume and

the Botswana inflation rate remains the same as in Exhibit 2.

Required:

(a) Compute the projected annual cash flow in Rands.

Answer 1

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