Juke plc is a UK manufacturer of specialist injection mouldings. Juke has just reported a 60% increase in turnover for the past year, and the Chairman’s statement in the annual report and accounts looks forward to even more rapid growth in the current year. The company has been growing steadily in previous years, though at a slower rate, and slightly increasing its share of a market that has been growing a little faster than the whole UK economy.
The most important factor contributing to the company’s recent rapid growth has been the retrenchment of Nemesis, one of its main competitors. Nemesis has recently been taken over by a private equity group, and has been pruning its less profitable product lines.
The Chairman believes that this trend is set to continue, creating increased opportunities for Juke. Despite the Chairman’s optimistic comments, some analysts have expressed concern about the financial position of the company. While cash holdings were £7.1 million a year ago, the latest statement of financial position (balance sheet) shows a cash balance of just £148,000 and an overdraft of £12.5 million. There has been no increase in the levels of long term finance during the year.
i) Explain what is meant by ‘overtrading’ and identify the symptoms that you would look for in order to determine whether Juke is overtrading. Which symptoms are indicated by the information provided?
ii) If we are to use the monetary approach to exchange rate determination, what will be the predicted effect on the exchange rate of domestic currency if domestic real income increases?
iii )Using the same theory, what would be the effect on exchange rate if domestic interest rate increases?