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In a typical financial year Lammer plc has net dollar imports of $4.2 million. This is
expected to continue for five years.
The company’s cost of capital is estimated to be 11% per year. Taxation may be
ignored, and cash flows may be assumed to occur at the year end.
Required:
Assuming that there is no change in the physical volume or dollar price of imports,
estimate the impact on the expected market value of Lammer plc if the market
expects the dollar to strengthen by 3% per year against the pound.What exactly does strengthening of dollar ‘against’ pound mean?
How are the exchange rate figures in the answer calculated?If the dollar is strengthening against the pound then it means 1 pound will buy fewer dollars (because the pound is getting more expense.
Given that here the $ is strengthening by 3% per year it means that the $/Pound exchange rate will fall by 3% a year.
The spot rate is 1.9156. So the rate in 1 years time will be 97% x 1.9156 = 1.8581. In 2 years time it will be 97% x 1.8581 = 1.8024, and so on 🙂
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