Suppose that Ashanti Gold Co. expects to produce a total of 1 million ounces of gold by the end of this year. Total manufacturing and operating cost will be $250 million and interest expenses will be $20 million. Ashanti forecasts the future gold price will be equally $250, $300, or $350. The firm's tax rate is 20 % when taxable income is equal to or less than $25 million, 30% when taxable income is greater than $25 million but less than $70 million, or 38% when taxable income is equal to or greater than $70 million. There is no tax obligation when the firm incurs negative profit. Assume that forward gold price is now $305 per ounce. If the firm decides to HEDGE 60 percent of its exposure to fluctuating gold price, how much will be the expected tax savings from this hedging activity?
See the attached file.
Profits & Loss Statement when no hedging is used
Gold Price $250 $300 $350
Below figures are in millions
Production Quantity (ounce) 1 1 1
Revenues $250.000 $300.000 $350.000
Cost of production $250.000 $250.000 $250.000
Operating profit $0.000 $50.000 $100.000
This solution shows step-by-step calculations in an Excel file to determine the expected tax savings from hedging activity on the fluctuating gold price.