On May 1, 2013, Mosby Company received an order to sell a machine to a customer in Canada at a price of 2,000,000 Mexican pesos. The machine was shipped and payment was received on March 1, 2014. On May 1, 2013, Mosby purchased a put option giving it the right to sell 2,000,000 pesos on March 1, 2014 at a price of $190,000. Mosby properly designates the option as a fair value hedge of the peso firm commitment. The option cost $3,000 and had a fair value of $3,200 on December 31, 2013. The following spot exchange rates apply: $\begin{array}{|l|c|}
\hline \text { Date } & \text { Spot Rate } \
\hline \text { May 1,2013 } & \$ 0.095 \
\hline \text { December 31,2013 } & \$ 0.094 \
\hline \text { March 1,2014 } & \$ 0.089 \
\hline
\end{array}$ Mosby's incremental borrowing rate is 12 percent, and the present value factor for two months at a 12 percent annual rate is .9803. What was the impact on Mosby's 2013 net income as a result of this fair value hedge of a firm commitment?
A)$1,760.60 decrease.
B)$1,960.60 decrease.
C)$1,000.00 decrease.
D)$1,760.60 increase.
E)$1,960.60 increase.

Question

Quizplus · Accepted Answer

The change in the fair value of the option from $3,000 to $3,200 results in a $200 increase. The change in the fair value of the firm commitment is calculated as the difference in spot rates from May 1 to December 31, 2013, which is $0.001 per peso, resulting in a $2,000 decrease (2,000,000 pesos * $0.001). The net impact on income is a $1,800 decrease ($2,000 decrease from the firm commitment offset by a $200 increase from the option). Adjusting for the present value factor of 0.9803, the impact is $1,760.60 decrease.

On May 1, 2013, Mosby Company Received an Order to Sell