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7115 · 6.1

Economic issues — practice questions

Practice and worked examples for 7115 Economic issues. Short previews only — attempt the full question in MarkScheme against the official scheme.

Worked example 1

A UK company has an existing variable-rate loan of £200,000 at the Central Bank Base Rate + 3%. The Base Rate increases from 1% to 4%. Calculate the increase in the company's annual interest payments.

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Step 1: Calculate the initial annual interest rate. Initial Rate=Base Rate+Premium=1%+3%=4%\text{Initial Rate} = \text{Base Rate} + \text{Premium} = 1\% + 3\% = 4\%

Step 2: Calculate the initial annual interest payment. Initial Payment=£200,000×4%=£200,000×0.04=£8,000\text{Initial Payment} = £200,000 \times 4\% = £200,000 \times 0.04 = £8,000

Step 3: Calculate the new annual interest rate. New Rate=New Base Rate+Premium=4%+3%=7%\text{New Rate} = \text{New Base Rate} + \text{Premium} = 4\% + 3\% = 7\%

Step 4: Calculate the new annual interest payment. New Payment=£200,000×7%=£200,000×0.07=£14,000\text{New Payment} = £200,000 \times 7\% = £200,000 \times 0.07 = £14,000

Step 5: Calculate the increase in annual interest payments. Increase=New Payment−Initial Payment=£14,000−£8,000=£6,000\text{Increase} = \text{New Payment} - \text{Initial Payment} = £14,000 - £8,000 = £6,000

Answer: The company's annual interest payments increase by £6,000. This directly reduces its profit before tax by the same amount.

Worked example 2

Brit-Tech Ltd, a UK company, imports components from the USA costing $100,000 and exports finished goods to Germany, generating revenue of EUR 250,000. Initially, the exchange rates are £1 = $1.25 and £1 = EUR 1.10. The rates change to £1 = $1.40 and £1 = EUR 1.15. Calculate the net impact on Brit-Tech's profit in GBP.

Show solution outline

Step 1: Calculate initial cost of imports in GBP. Cost in GBP = Total USD Cost / Exchange Rate ($ per £) Initial Import Cost=$100,0001.25=£80,000\text{Initial Import Cost} = \frac{\text{\textdollar}100,000}{1.25} = £80,000

Step 2: Calculate initial revenue from exports in GBP. Revenue in GBP = Total EUR Revenue / Exchange Rate (EUR per £) Initial Export Revenue=EUR 250,0001.10≈£227,273\text{Initial Export Revenue} = \frac{\text{EUR } 250,000}{1.10} \approx £227,273

**Step 3: Calculate new cost of imports in GBP (after £ appreciation vs ).∗∗).** The pound gets stronger, so imports are cheaper. New Import Cost=$100,0001.40≈£71,429\text{New Import Cost} = \frac{\text{\textdollar}100,000}{1.40} \approx £71,429 Change in import cost = £80,000 - £71,429 = +£8,571 (a positive impact on profit).

Step 4: Calculate new revenue from exports in GBP (after £ appreciation vs EUR). The pound also gets stronger against the Euro, so export revenue is worth less in GBP. New Export Revenue=EUR 250,0001.15≈£217,391\text{New Export Revenue} = \frac{\text{EUR } 250,000}{1.15} \approx £217,391 Change in export revenue = £217,391 - £227,273 = -£9,882 (a negative impact on profit).

Step 5: Calculate the net impact on profit. Net Impact = Change in Import Cost + Change in Export Revenue Net Impact=£8,571+(−£9,882)=−£1,311\text{Net Impact} = £8,571 + (-£9,882) = -£1,311

Answer: The net impact of the exchange rate movements is a decrease in profit of approximately £1,311. The negative effect from lower export revenue was greater than the positive effect from cheaper imports.

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