The specialty chemical Company operates a crude oil refinery located in New Iber

Question

The specialty chemical Company operates a crude oil refinery located in New Iberia, LA. The company refines crude oil and sells the by-products to companies that make plastic bottles and jugs. The firm is currently planning for its refining needs for one year hence. Specifically, the firms analysts estimate that specialty will need to purchase 1 millionbarrels of crude oil at the end of of the current year to provide the feed stock for its refining needs for the coming year. The 1 million barrels of crude oil will be converted into by products at an average cost of $30 per barrel that Specialty expects to sell for $175 million, or $175 per barrel of crude used. The current spot price of oil is $120 per barrel and Specialty has been offered a forward contract by its investment banker to purchase the needed oil for a delivery price in one year of $125 per barrel.

A. Ignoring taxes, what will Specialty's profits be if oil prices in one year are as low as $105 or as high as $145, assuming that the firm does not enter into the forward contract?

B. If the firm were to enter into forward contract, demonstrate how this would be effectively lock in the firm's cost of fuel today, thus hedging the risk of fluctuating crude oil prices on the firm's profits for the next year.

A. Ignoring taxes, what will specialty's profits be if oil prices in one year are as low as $105 or as high as $145, assuming that the firm does not enter into forward contract? Round to the nearest dollar. Answer 255,200

Price of Oil/ bbl Unhedged Annual Profits
$105 _________
$110 _________
$115 _________
$120 _________
$125 _________
$130 _________
$135 _________
$140 _________
$145 _________

Explanation / Answer

A. Ignoring taxes, what will Specialty's profits be if oil prices in one year are as low as $105 or as high as $145, assuming that the firm does not enter into the forward contract? ========================================================================================================================== At a price of $105 per barrel, $30 per barrel conversion cost, selling at $175 per barrel, their profits will be. ============================================================================================================================ This is assuming that 1 million barrels are sold and that the firm does not enter into the forward contract. ==============================================================================================================================================================================================

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