Then, tit other assumptions about revenue and cost we could calculate the free cash flows of 1985-1989 and the terminal value. The firm value is the sum of present value (at 1984) of cash flows and the terminal value, GAP 510. 977,000. For the scenario (B), there are more things to consider due to the change in real exchange rate. Since the real value of the dollar dropped by 25% in 1985, the nominal exchange rate become USED 1. 655/ GAP. We also assume Jaguar’s 10% increase in USED prices which is $28,194 in 1985. Price elasticity of demand was low so that 10% changes in price exulted in 2% growth of the volume.
And we applied the same logic to further year’s cash flow and the terminal value. Then we discounted future cash flows and the terminal value to achieve GAP 215,492,000. QUESTION 2: What is the company’s exposure to exchange rate? Jaguar, as a U. K. – based exporter to U. S. Market, is exposed to exchange rate risk as more than half of its sales occur in USED while its production cost occurs in GAP. For this reason, Jaguar’s firm value (NAP of future free cash flows) may change in response to the change in the interest rate.
Questions : What do you recommend to hedge this exposure? Jaguar is facing huge amount of the exchange rate risk. Hedging can give the firm few advantages. First, the value could be created by reducing the volatility of the firm value. Second, firms can hedge with less transaction costs than individual investors. In conclusion, even though the hedging may incur a lot of costs, cause future improper incentives, or result in difficulties in controlling, it is beneficial in a way that the hedging itself reduces the volatility of the firm value and creates value.