MAF334 UNSEEN 2 – 19 April 2016 Marks: 33

Reading time: 10 minutes

Writing time: 50 minutes

PART A (23 marks)

First Wave (Pty) Ltd manufactures specialised videography equipment using materials and
components that are imported from the United States (U.S.). Monthly imports from the U.S.
amount to roughly $1 million worth of goods. Suppliers offer free credit for one month, after
which interest is charged at 2.5% per annum.

First Wave currently exports its products to many different countries around the world. As a
result of the volatile exchange rate of South Africa (S.A.) First Wave has a policy to hedge all
transactions using the hedging instrument that is the most attractive for each transaction.

Big U.S. order

First Wave has been in negotiations with a major U.S. film company and has sent out a quote
on 3 April 2016 for $750 000. It is expected that an order (in line with the quote) will be
received from this customer on 1 May 2016. A cash deposit of 25% is required on the date of
the order, and manufacturing of the equipment will start immediately. The outstanding
amount is due on the delivery date of 31 July 2016.

During negotiations, the customer indicated that it might be willing to make full payment of
the outstanding amount on 1 June 2016, if they are granted a discount of 10% on the
outstanding amount due.

Available hedging strategies

First Wave can make use of the following three hedging strategies, depending on which one
is the most advantageous: Forward Exchange Contract (FEC), Money Market Hedge or
Currency Options.

The following ZAR:USD direct exchange rates are available:

Bid Offer
Spot rates on 1 May 2016 14.57 14.66
FEC Forward rate (31 July 2016) 14.82 14.93

The following interest rates will apply for the foreseeable future:

Deposit Borrowing
South Africa 6.5% 12.0%
United States 0.8% 2.5%

On 1 May 2016, First Wave can purchase a call or a put option with a strike price of R14.83
which is exercisable on 31 July 2016. The option can be purchased at a premium of 2.2%,
calculated on the spot price at the date of purchasing the option.
REQUIRED

PART A (23 marks)

1) Recommend which of the three hedging strategies would be most advantageous to First
Wave. Support you recommendation with calculations.
(10 marks)

2) Calculate at which spot rate the option contract would be most advantageous.

(3 marks)

3) Briefly describe what other strategies could be followed to hedge against foreign
exchange risk. You need to calculate the costs and show supporting calculations.
(4 marks
Plus: 4 bonus marks)

4) Briefly explain to the directors of First Wave how the exchange rate between the U.S. and
South Africa is influenced by the following factors:

a. Political uncertainty in South Africa (3 marks)

b. The interest rate differentials between the two countries (3 marks)

PART B (max 8 marks, 9 marks presented below)

Part B relates to the ABC tutorials due for this week, and not to the scenario provided.

5) AB04: What was Otis Protective Coatings’ likely rationale behind the decision to use
revenue instead of production volumes as a basis to allocate overhead costs? (2 marks)

6) AB04: Give 2 reasons why using an ABC system is likely to be of benefit to Otis
Protective coatings (Pty) Ltd, with regards to improving decision making as detailed by
Ben Bull? (2 marks)

7) AB02: Part 6 asks – “What shortcomings might exist regarding the ABC cost allocation?”
Identify and explain what the (specific) problem was with how the overhead rate per
activity was calculated for fixed costs, in this question. (2 marks)

8) AB01: With reference to the cost of dye currently included in variable overheads to the
Leather Treatment cost pool and the metals studs and piping currently included in
variable overheads in the Assembly and Stuffing cost pool:

Have these costs been correctly included in the cost pools, or not? Compare and contrast
the appropriate treatment of these costs, briefly explaining the appropriate treatment.
(3 marks)

Efficient and effective communication (2 marks)