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So if the assistant treasurer was right that the worst case was for the yen to strengthen to 222
¥/$, then the company would report a loss of $14 million compared to the loan in dollars.
Exhibit 7.24 Correct analysis of loan assuming worst case of 222 ¥/$ (in millions).
The assistant treasurer missed the principal repayment because he did not make a cash flow
time line. It was an easy mistake to make. Let‟s do a time line for him (Exhibit 7.25).
Looking quickly at this time line, we see that the amount of the principal payment dominates
the interest charges. The effect of the exchange rate on the principal had the same kind of
devastating effect on Unknown Rental Cars as it did on your CD in England. In both cases the
effect was not expected. However, in the case of Unknown, this simple analysis of the worst case
would have shown the problem. Unfortunately, the expected worst case was not as bad as reality.
You were in good company forgetting to consider the effect of foreign exchange movements
on the principal. Let‟s jump ahead in time and look at the actual history for year-end exchange
rates and what they imply for the principal repayment (Exhibit 7.26).
Exhibit 7.25 Cash flow time line for loan options (in millions).
Exhibit 7.26 Actual yen-dollar exchange rates and effect of Japanese loan on liability in dollars
(in millions).