What is the net impact on Black Lion Company’s Year 2 net income as a result of this hedge of a forecasted foreign currency purchase? Assume that the raw materials are consumed and become a part of cost of goods sold in Year 2.

Question Completion:

What is the net impact on Black Lion Company's Year 2 net income as a result of this hedge of a forecasted foreign currency purchase? Assume that the raw materials are consumed and become a part of cost of goods sold in Year 2.

a. A $70,000 decrease in net income.

b. A $70,900 decrease in net income.

c. A $71,100 decrease in net income.

d. A $72,900 decrease in net income.

On November 1, Year 1, Black Lion Company forecasts the purchase of raw materials from an Argentinian supplier on February 1, Year 2, at a price of 200,000 Argentine pesos. On November 1, Year 1, Black Lion pays $1,200 for a three-month call option on 200,000 Argentinian pesos with a strike price of $0.35 per peso. The option is properly designated as a cash flow hedge of a forecasted foreign currency transaction. On December 31, Year 1, the option has a fair value of $900. The following spot exchange rates apply:

Date                  Spot Rates

Nov. 1, Year 1       $0.35

Dec. 1, Year 1         0.30

Feb. 1, Year 2        0.36

Black Lion Company

The net impact on Black Lion Company's Year 2 net income as a result of this hedge of a forecasted foreign currency purchase is:

b. A $70,900 decrease in net income

Explanation:

Black Lion Company will pay Argentine peso 200,000 * $0.35, the spot rate when the forward contract was concluded = $70,000 and also the options fair value of $900.  This reduces the net income by a total of $70,900 ($70,000 + $900).  The reduction does not take place in Year 1 when the transaction is initiated, but when the raw materials are consumed and become a part of the cost of goods.  This is Year 2.  We are aware that Cost of goods reduces the net income.

answer: heh

explanation:

answer; bootstrapping is your answer;