Example:

Suppose that a U.S. computer company has a wholly owned British subsidiary, Albion Computer PLC, that manufactures and sells personal computers in the UK market. AC PLC imports microprocessors from Intel, which sells them for $512 per unit. At the current exchange rate of $1.60 per pound, each Intel microprocessor costs £320. AC PLC hires British workers and sources all the other inputs locally. The company faces a 50% income tax in the UK.

Projected operations for AC PLC: Benchmark case ($1.60/£):

Sales (50,000 units at £1,000/units) £ 50,000,000

Variable costs (£650/unit)* 32,500,000

Fixed costs 4,000,000

Depreciation 1,000,000

Net profit before tax 12,500,000

Income tax (at 50%) 6,250,000

Profit after tax 6,250,000

Add back depreciation 1,000,000

Operating cash flow in pounds 7,250,000

Operating cash flow in dollars $11,600,000

Now, consider the possible effect of a depreciation of pound on the projected dollar operating cash flow of AC PLC. Assume that the pound may depreciate from $1.60 to $1.40 per pound.

*: the unit variable cost, £650, comprises £330 for locally sourced input and £320 for the imported input.

Case 1: No variables change, except the price of imported input.

Sales ( units at £ /units) £

Variable costs (£ /unit)

Fixed costs

Depreciation

Net profit before tax

Income tax (at 50%)

Profit after tax

Add back depreciation

Operating cash flow in pounds

Operating cash flow in dollars $

Case 2: the selling price as well as the price of the imported input changes, with no other changes.

Sales ( units at £ /units) £

Variable costs (£ /unit)

Fixed costs

Depreciation

Net profit before tax

Income tax (at 50%)

Profit after tax

Add back depreciation

Operating cash flow in pounds

Operating cash flow in dollars $

Case 3: all the variables change (UK has a inflation rate of 8%).

Sales (40,000 units at £1,080/units) £

Variable costs (£722/unit)

Fixed costs

Depreciation

Net profit before tax

Income tax (at 50%)

Profit after tax

Add back depreciation

Operating cash flow in pounds

Operating cash flow in dollars $

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