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    Hedging and Expected Tax Saving

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    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?

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    Solution Preview

    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
    Interest ...

    Solution Summary

    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.