Chap12 Pbms MBF12e

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Pbm12.1
	
		Problem 12.1 Kona Macadamia Nuts
	
		Kona Macadamia Nuts, based in Hilo, Hawaii, exports Macadamia nuts worldwide. The Japanese market is its biggest export market, with average annual sales invoiced in yen to Japanese customers of ¥1,200,000,000. At the present exchange rate of ¥125/$ this is equivalent to $9,600,000. Sales are relatively equally distributed during the year. They show up as a ¥250,00,000 account receivable on Kona’ balance sheet. Credit terms to each customer allow for 60 days before payment is due. Monthly cash collections are typically ¥100,000,000. 
Kona Macadamia Nuts would like to hedge its yen receipts, but it has too many customers and transactions to make it practical to sell each receivable forward. It does not want to use options because they are considered to be too expensive for this particular purpose. Therefore, they have decided to use a “matching” hedge by borrowing yen.
	
	
	
	
	
	
	
	
	
		a. How much should Kona borrow in yen?
	
		Kona receives cash collections of one hundred million yen per month. This is the source of repayment of any
		balance sheet hedge. If Kona wants to be covered for one year at a time, it would need to borrow one year's
		cash flow plus interest, and convert the borrowed yen to US dollar at once. A sample calculation would be:
	
				Sample Values		Units
		One month's cash flow		* 100,000,000		Yen
		Months per year		* 12
		One year's cash flow		* 1,200,000,000		Yen
		Plus interest		4.000%		per annum
		Principal and interest		* 1,248,000,000		Yen
		Spot exchange rate		* 125.00		Yen/US$
		US dollars		$9,984,000		US$
	
		Realistically, Kona would probably want to be covered for the long term. In that case, the 1.2 billion yen loan
		could be structured so that it could be renewed annually with interest reset annually. This would only cover the
		foreign exchange and interest rate risk for a year at a time, but would probably be acceptable to a bank lender.
		Also unknown are the expected sales for year 2 and beyond.
	
		b. What should be the terms of payment on the loan?
	
		The loan should be repaid out of the monthly cash flow, with payments on principal only. The interest payment one
		year hence has already been covered by borrowing both principal and interest up-front.
	
		Note: Kona should not borrow 250 million yen to cover only its balance sheet exposure. Such a loan would cover
		only the accounting exposure, and not the cash flow exposure (operating exposure).
Pbm12.2
	
		Problem 12.2 Newport Lifts (A)
	
		Newport Lifts (USA) exports heavy crane equipment to several Chinese dock facilities. Sales are currently 10,000 units per year at the yuan equivalent of $24,000 each. The Chinese yuan (renminbi) has been trading at Yuan8.20/$, but a Hong Kong advisory service predicts the renminbi will drop in value next week to Yuan9.00/$, after which it will remain unchanged for at least a decade. Accepting this forecast as given, Newport Lifts faces a pricing decision in the face of the impending devaluation. It may either (1) maintain the same yuan price and in effect sell for fewer dollars, in which case Chinese volume will not change; or (2) maintain the same dollar price, raise the yuan price in China to offset the devaluation, and experience a 10% drop in unit volume. Direct costs are 75% of the U.S. sales price.
	
	
	
	
	
	
	
	
	
		Assumptions		Values
		Sales volume per year		* 10,000
		US dollar price per unit		$24,000
		Direct costs as % of US$ sales price		75%
		Direct costs per unit		$18,000.00
		Spot exchange rate, yuan/$		* 8.2000
		Expected spot rate, yuan/$		* 9.2000
		Unit volume decrease if price increased		-10%
	
				Case 1		Case 2
		Sales to China		Same Yuan Price		Same US$ Price
	
		US dollar price per unit		$21,391.30		$24,000.00
		Unit volume		* 10,000		* 9,000
	
		Sales revenue		$213,913,043		$216,000,000
		Less direct costs		($180,000,000)		($162,000,000)
		Gross profits		$33,913,043		$54,000,000
						Better.
Pbm12.3
	
		Problem 12.3 Newport Lifts (B)
	
		Assume the same facts as in Newport Lifts (A). Additionally, financial management believes that if it maintains the same yuan sales price, volume will increase at 12% per annum for eight years. Dollar costs will not change. At the end of ten years, Newport Lift’s patent expires and it will no longer export to China. After the yuan is devalued to Yuan9.20/$, no further devaluations are expected. If Newport Lifts raises the yuan price so as to maintain its dollar price, volume will increase at only 1% per annum for eight years, starting from the lower initial base of 9,000 units. Again dollar costs will not change and at the end of eight years, Newport will stop exporting to China. Newport's weighted average cost of capital is 10%. Given these considerations, what should be Newport's pricing policy?
	
	
	
	
	
		Assumptions		Values				Assumptions		Values
		Sales volume per year		* 10,000				Volume change		1%
		US dollar price per unit		$24,000				(if price increased)
		Direct costs as % of US$ price		75%				Volume growth		12%
		Direct costs per unit		$18,000				(same Rmb price)
		Spot exchange rate, yuan/$		* 8.2000				WACC		10%
		Expected spot rate, yuan/$		* 9.2000
	
		Alternative 1: Keep Same Chinese Sales Price
										Gross		Present Value		Present Value
		Year		Volume		Revenue		Direct Costs		Margin		Factor		of Margin
		1		* 10,000		$213,913,043		$180,000,000		$33,913,043		* 0.9091		$30,830,040
		2		* 11,200		$239,582,609		$201,600,000		$37,982,609		* 0.8264		$31,390,586
		3		* 12,544		$268,332,522		$225,792,000		$42,540,522		* 0.7513		$31,961,324
		4		* 14,049		$300,532,424		$252,887,040		$47,645,384		* 0.6830		$32,542,439
		5		* 15,735		$336,596,315		$283,233,485		$53,362,830		* 0.6209		$33,134,119
		6		* 17,623		$376,987,873		$317,221,503		$59,766,370		* 0.5645		$33,736,558
		7		* 19,738		$422,226,418		$355,288,083		$66,938,335		* 0.5132		$34,349,950
		8		* 22,107		$472,893,588		$397,922,653		$74,970,935		* 0.4665		$34,974,494
		Cum PV of Gross Margin												$262,919,509
	
		Alternative 2: Raise Chinese Sales Price
										Gross		Present Value		Present Value
		Year		Volume		Revenue		Direct Costs		Margin		Factor		of Margin
		1		* 9,000		$216,000,000		$162,000,000		$54,000,000		* 0.9091		$49,090,909
		2		* 9,090		$218,160,000		$163,620,000		$54,540,000		* 0.8264		$45,074,380
		3		* 9,181		$220,341,600		$165,256,200		$55,085,400		* 0.7513		$41,386,476
		4		* 9,273		$222,545,016		$166,908,762		$55,636,254		* 0.6830		$38,000,310
		5		* 9,365		$224,770,466		$168,577,850		$56,192,617		* 0.6209		$34,891,194
		6		* 9,459		$227,018,171		$170,263,628		$56,754,543		* 0.5645		$32,036,460
		7		* 9,554		$229,288,353		$171,966,264		$57,322,088		* 0.5132		$29,415,295
		8		* 9,649		$231,581,236		$173,685,927		$57,895,309		* 0.4665		$27,008,589
		Cum PV of Gross Margin												$296,903,613
	
		Newport Lifts is better off raising the Chinese sales price to maintain the US dollar price, and suffering the lower volumes. The volume decrease does not offset the stronger US dollar price per unit received.
Pbm12.4
	
		Problem 12.4 Pucini's Risk-Sharing
	
		Pucini Leather, based in New York City, imports leather coats from Boselli Leather Goods, a reliable and longtime supplier, based in Buenos Aires, Argentina. Payment is in Argentine pesos. When the peso lost its parity with the U.S. dollar in January 2002 it collapsed in value to Ps 4.0/$ by October 2002. The outlook was for a further decline in the peso’s value. Since both Pucini and Boselli wanted to continue their longtime relationship they agreed on a risk-sharing arrangement. As long as the spot rate on the date of an invoice is between Ps3.5/$ and Ps4.5/$ Pucini will pay based on the spot rate. If the exchange rate falls outside this range they will share the difference equally with Boselli Leather Goods. The risk-sharing agreement will last for six months, at which
time the exchange rate limits will be reevaluated. Pucini Fashionwear contracts to import leather coats from Boselli for Ps8,000,000 or $2,000,000 at the current spot rate of Ps4.0/$ during the next six months.
	
	
	
	
	
	
	
	
	
	
		a. If the exchange rate changes immediately to Ps6.00/$, what will be the dollar cost of 6 months of imports to Pucini?
	
	
				Bottom		Top
		The allowable range of exchange rates is (Ps/$)		* 3.50		* 4.50
	
		Outside of this range the trading partners will share the extra risk equally.
	
		New exchange rate (Ps/$)		* 6.00
		Allowable exchange rate (Ps/$)		* 4.50
		Difference to be shared (Ps/$)		* 1.50
		Pucinii's share		* 0.75
		Boselli's share		* 0.75
	
		Therefore, Pucini will use the following effective exchange rate after risk-sharing:
	
		Top of range		* 4.50
		Pucini's share		* 0.75
		Effective total of risk-sharing		* 5.25
	
		Assuming that 6 months of imports will still be (Ps)		* 8,000,000
		Effective exchange rate for Pucini (Ps/$)		* 5.25
		Pucini's cost in US dollars		$1,523,809.52
	
		However, the lower cost of importing might lead to higher Pucini sales and therefore a higher import total than Ps 8 million.
	
	
		b. At Ps6.00/$, what will be the peso export sales in Boselli to Pucini?
	
		The export sales of Boselli would remain at Ps 8 million, unless the lower dollar cost encourages Pucini to import more from Boselli.
Pbm12.5
	
		Problem 12.5 Morris Garage, Ltd.
	
		Morris Garage, Ltd., of Coventry, England, manufactures British sports cars, a number of which are exported to New Zealand for payment in pounds sterling. The distributor sells the sports cars in New Zealand for New Zealand dollars. The New Zealand distributor is unable to carry all of the foreign exchange risk, and would not sell Morris models unless Morris could share some of the foreign exchange risk. Morris has agreed that sales for a given model year will initially be priced at a “base” spot rate between the New Zealand dollar and pound sterling set to be the spot mid-rate at the beginning of that model year. As long as the actual exchange rate is within ±5% of that base rate, payment will be made in pounds sterling. I.e., the New Zealand distributor assumes all foreign exchange risk. However if the spot rate at time of shipment falls outside of this ±5% range, Morris will share equally (i.e., 50/50) the difference between the actual spot rate and the base rate. For the current model year the base rate is NZ$1.6400/£.
	
	
	
	
	
	
	
	
	
	
		Assumptions		Values
		Invoice price of car		£12,000
		Spot exchange rate, NZ$/£		* 1.6400
		Risk-sharing band, percentage +/-		5.00%
	
		Sales to New Zealand Distributors		Lower Band		Upper Band
	
		a. What are the outside ranges?		* 1.7220		* 1.5580
		(initial spot rate + or - 5%)
	
		b. Cost to the Kiwi distributor for 10 cars
	
		New current spot rate (N$/£)		* 1.7000
		Is this within the band?		Yes
		Cost of 10 cars at this exchange rate (NZ$)		* 204,000
	
		Receipts to Morris in British pounds		£120,000
		(Within the band Morris receives £12,000/car, as expected)
	
		c. Cost to the Kiwi distributor for 10 cars
	
		New current spot rate (N$/£)		* 1.6500
		Is this within the band?		Yes
		Cost of 10 cars at this exchange rate (NZ$)		* 198,000
	
		Receipts to Morris in British pounds		£120,000
		(Within the band Morris receives £12,000/car)
	
		d. How does this shift the currency risk?
	
		Morris bears no risk within the 5% range. The distributor carries all of the risk within 5%. If the exchange rate falls outside the 5% range, Morris shares the risk with the distributor.
	
	
		e. Who benefits from this risk-sharing agreement?
	
		Both parties in practice. The manufacturer has predictable revenues within the range, while the distributor bears a moderate level of currency risk within the 5% range. The distributor will hopefully be able to provide a more stable pricing to pass on to the customer, which will also benefit the manufacturer through a more stable and sustinable distributor sales outlet.
Pbm12.6
	
		Problem 12.6 Trident Europe: Case 4
	
		Trident Europe (Exhibit 12.3) decides not to change its domestic price of €12.80 per unit within Europe, but to raise its export price (in euros) from €12.80 per unit to €15.36 per unit, thus preserving its original dollar equivalent price of $15.36 per unit. Volume in both markets remains the same because no buyer perceives that the price has changed.
	
	
	
		Balance Sheet Information, End of Fiscal 2005
		Assets		Liabilities and net worth
		Cash	€ 1,600,000	Accounts payable		€ 800,000
		Accounts receivable	* 3,200,000	Short-term bank loan		* 1,600,000
		Inventory	* 2,400,000	Long-term debt		* 1,600,000
		Net plant and equipment	* 4,800,000	Common stock		* 1,800,000
				Retained earnings		* 6,200,000
		Sum	€ 12,000,000	Sum		€ 12,000,000
	
			Important Ratios to be Maintained and Other Data
			Accounts receivable, as percent of sales			25.00%
			Inventory, as percent of annual direct costs			25.00%
			Cost of capital (annual discount rate)			20.00%
			Income tax rate			34.00%
	
				Base Case	Case 1	Case 2	Case 3	Case 4
		Assumptions
		Exchange rate, $/€		1.2000	1.0000	1.0000	1.0000	1.0000
		Sales volume (units)		1,000,000	1,000,000	2,000,000	1,000,000	500,000
		Export sales volume (case 4)						500,000
		Sales price per unit		€ 12.80	€ 12.80	€ 12.80	€ 15.36	€ 12.80
		Export sales price per unit (case 4)						€ 15.36
		Direct cost per unit		€ 9.60	€ 9.60	€ 9.60	€ 9.60	€ 9.60
		Annual Cash Flows before Adjustments
		Sales revenue		€ 12,800,000	€ 12,800,000	€ 25,600,000	€ 15,360,000	€ 14,080,000
		Direct cost of goods sold		* 9,600,000	* 9,600,000	* 19,200,000	* 9,600,000	* 9,600,000
		Cash operating expenses (fixed)		* 890,000	* 890,000	* 890,000	* 890,000	* 890,000
		Depreciation		* 600,000	* 600,000	* 600,000	* 600,000	* 600,000
		Pretax profit		€ 1,710,000	€ 1,710,000	€ 4,910,000	€ 4,270,000	€ 2,990,000
		Income tax expense		* 581,400	* 581,400	* 1,669,400	* 1,451,800	* 1,016,600
		Profit after tax		€ 1,128,600	€ 1,128,600	€ 3,240,600	€ 2,818,200	€ 1,973,400
		Add back depreciation		* 600,000	* 600,000	* 600,000	* 600,000	* 600,000
		Cash flow from operations, in euros		€ 1,728,600	€ 1,728,600	€ 3,840,600	€ 3,418,200	€ 2,573,400
		Cash flow from operations, in dollars		$2,074,320	$1,728,600	$3,840,600	$3,418,200	$2,573,400
	
		Adjustments to Working Capital for 2006 - 2010 Caused by Changes in Conditions
		Accounts receivable		€ 3,200,000	€ 3,200,000	€ 6,400,000	€ 3,840,000	€ 3,520,000
		Inventory		* 2,400,000	* 2,400,000	* 4,800,000	* 2,400,000	* 2,400,000
		Sum		€ 5,600,000	€ 5,600,000	€ 11,200,000	€ 6,240,000	€ 5,920,000
		Change from base conditions in 2006		0.0	0.0	€ 5,600,000	€ 640,000	€ 320,000
	
			Year	Year-End Cash Flows
			1 (2006)	$2,074,320	$1,728,600	$(1,759,400)	$2,778,200	$2,253,400
			2 (2007)	$2,074,320	$1,728,600	$3,840,600	$3,418,200	$2,573,400
			3 (2008)	$2,074,320	$1,728,600	$3,840,600	$3,418,200	$2,573,400
			4 (2009)	$2,074,320	$1,728,600	$3,840,600	$3,418,200	$2,573,400
			5 (2010)	$2,074,320	$1,728,600	$9,440,600	$4,058,200	$2,893,400
			Year	Change in Year-End Cash Flows from Base Conditions
			1 (2006)	na	$(345,720)	$(3,833,720)	$703,880	$179,080
			2 (2007)	na	$(345,720)	$1,766,280	$1,343,880	$499,080
			3 (2008)	na	$(345,720)	$1,766,280	$1,343,880	$499,080
			4 (2009)	na	$(345,720)	$1,766,280	$1,343,880	$499,080
			5 (2010)	na	$(345,720)	$7,366,280	$1,983,880	$819,080
				Present Value of Incremental Year-End Cash Flows
				na	$(1,033,914)	$2,866,106	$3,742,892	$1,354,489
Pbm12.7
	
		Problem 12.7 Trident Europe: Case 5
	
		Trident Europe (Exhibit 12.3) finds that domestic costs increase in proportion to the drop in value of the euro because of local inflation and a rise in the cost of imported raw materials and components. This rise in costs (+20%) applies to all cash costs, including direct
costs and fixed cash operating costs. However it does not apply to depreciation. Because of the increase in its costs Trident Europe increases its sales price in euros from €12.80 per unit to €15.36 per unit.
	
	
	
	
		Balance Sheet Information, End of Fiscal 2005
		Assets		Liabilities and net worth
		Cash	€ 1,600,000	Accounts payable		€ 800,000
		Accounts receivable	* 3,200,000	Short-term bank loan		* 1,600,000
		Inventory	* 2,400,000	Long-term debt		* 1,600,000
		Net plant and equipment	* 4,800,000	Common stock		* 1,800,000
				Retained earnings		* 6,200,000
		Sum	€ 12,000,000	Sum		€ 12,000,000
	
			Important Ratios to be Maintained and Other Data
			Accounts receivable, as percent of sales			25.00%
			Inventory, as percent of annual direct costs			25.00%
			Cost of capital (annual discount rate)			20.00%
			Income tax rate			34.00%
	
				Base Case	Case 1	Case 2	Case 3	Case 5
		Assumptions
		Exchange rate, $/€		1.2000	1.0000	1.0000	1.0000	1.0000
		Sales volume (units)		1,000,000	1,000,000	2,000,000	1,000,000	500,000
		Export sales volume (case 4)						500,000
		Sales price per unit		€ 12.80	€ 12.80	€ 12.80	€ 15.36	€ 15.36
		Export sales price per unit (case 4)						€ 15.36
		Direct cost per unit		€ 9.60	€ 9.60	€ 9.60	€ 9.60	€ 11.52
		Annual Cash Flows before Adjustments
		Sales revenue		€ 12,800,000	€ 12,800,000	€ 25,600,000	€ 15,360,000	€ 15,360,000
		Direct cost of goods sold		* 9,600,000	* 9,600,000	* 19,200,000	* 9,600,000	* 11,520,000
		Cash operating expenses (fixed)		* 890,000	* 890,000	* 890,000	* 890,000	* 1,068,000
		Depreciation		* 600,000	* 600,000	* 600,000	* 600,000	* 600,000
		Pretax profit		€ 1,710,000	€ 1,710,000	€ 4,910,000	€ 4,270,000	€ 2,172,000
		Income tax expense		* 581,400	* 581,400	* 1,669,400	* 1,451,800	* 738,480
		Profit after tax		€ 1,128,600	€ 1,128,600	€ 3,240,600	€ 2,818,200	€ 1,433,520
		Add back depreciation		* 600,000	* 600,000	* 600,000	* 600,000	* 600,000
		Cash flow from operations, in euros		€ 1,728,600	€ 1,728,600	€ 3,840,600	€ 3,418,200	€ 2,033,520
		Cash flow from operations, in dollars		$2,074,320	$1,728,600	$3,840,600	$3,418,200	$2,033,520
	
		Adjustments to Working Capital for 2006 - 2010 Caused by Changes in Conditions
		Accounts receivable		€ 3,200,000	€ 3,200,000	€ 6,400,000	€ 3,840,000	€ 3,840,000
		Inventory		* 2,400,000	* 2,400,000	* 4,800,000	* 2,400,000	* 2,880,000
		Sum		€ 5,600,000	€ 5,600,000	€ 11,200,000	€ 6,240,000	€ 6,720,000
		Change from base conditions in 2006		0.0	0.0	€ 5,600,000	€ 640,000	€ 1,120,000
	
			Year	Year-End Cash Flows
			1 (2006)	$2,074,320	$1,728,600	$(1,759,400)	$2,778,200	$913,520
			2 (2007)	$2,074,320	$1,728,600	$3,840,600	$3,418,200	$2,033,520
			3 (2008)	$2,074,320	$1,728,600	$3,840,600	$3,418,200	$2,033,520
			4 (2009)	$2,074,320	$1,728,600	$3,840,600	$3,418,200	$2,033,520
			5 (2010)	$2,074,320	$1,728,600	$9,440,600	$4,058,200	$3,153,520
			Year	Change in Year-End Cash Flows from Base Conditions
			1 (2006)	na	$(345,720)	$(3,833,720)	$703,880	$(1,160,800)
			2 (2007)	na	$(345,720)	$1,766,280	$1,343,880	$(40,800)
			3 (2008)	na	$(345,720)	$1,766,280	$1,343,880	$(40,800)
			4 (2009)	na	$(345,720)	$1,766,280	$1,343,880	$(40,800)
			5 (2010)	na	$(345,720)	$7,366,280	$1,983,880	$1,079,200
				Present Value of Incremental Year-End Cash Flows
				na	$(1,033,914)	$2,866,106	$3,742,892	$(605,247)
Pbm12.8
	
		Problem 12.8 Dzell Printers, Inc. (A)
	
		Dzell Printers, Inc. (DP) of the United States exports computer printers to Brazil, whose currency, the reais (symbol R$) has been trading at R$3.40/US$. Exports to Brazil are currently 50,000 printers per year at the reais equivalent of $200 each. A strong rumor exists that the reais will be devalued to R$4.00/$ within two weeks by the Brazilian government. Should the devaluation take place, the reais is expected to remain unchanged for another decade. 
Accepting this forecast as given, DP faces a pricing decision which must be made before any actual devaluation: DP may either (1) maintain the same reais price and in effect sell for fewer dollars, in which case Brazilian volume will not change, or (2) maintain the same dollar price, raise the reais price in Brazil to compensate for the devaluation, and experience a 20% drop in volume. Direct costs in the U.S. are 60% of the U.S. sales price. What would be the short-run (one-year) implication of each pricing strategy? Which do you recommend?
	
	
	
	
	
	
	
	
	
						Exchange rate		Prices in
		Assumptions		US dollar prices		(R$/$)		Brazilian reais
		Existing sales price per unit		$200.00	→	* 3.4000	→	* 680
	
		If the reais falls in value, the new implied US$ price:
		New dollar price if no reais price change		$170.00	←	* 4.0000	←	* 680
	
		If the US$ price is changed to keep US$ price:
		New reais price is current US$ price at new exchange rate:		$200.00	→	* 4.0000	→	* 800
	
		Direct cost per unit in the US, percent of price		60%
		Direct cost per unit in the US		$120.00		* 3.4000		* 408
	
		Unit volume		* 50,000
		Decrease in unit volume from price increase		-20.0%
		New lower unit volume		* 40,000
	
		Alternative #1: Maintain same price in reais:
	
		Sales revenue (R$680 x 50,000 ) / (R$4.000/$)		$8,500,000
		Less direct costs (US$120 x 50,000)		* 6,000,000
		Contribution margin in US dollars		$2,500,000
	
		Alternative #2: Raise price in reais (and accept lower volume):
	
		Sales revenue (R$800 x 40,000 ) / (R$4.000/$)		$8,000,000
		Less direct costs (US$120 x 40,000)		* 4,800,000
		Contribution margin in US dollars		$3,200,000
	
		Discussion
		Alternative #2 is preferable. In the short run (one year), DP would be better off to increase its sales price in reais in Brazil and accept the lower sales volume. The contribution margin if reais prices are raised is $3,200,000, whereas if the price in reais is left unchanged DP's contribution margin is only $2,500,000. This is a short-run solution, and does not consider possible longer-run effects that might come from raising the local price and/or accepting a smaller market share.
Pbm12.9
	
		Problem 12.9 Dzell Printers, Inc. (B)
	
	Assume the same facts as in Dzell Printers (A). Dzell also believes that if it maintains the same price in Brazilian reais as a permanent policy, volume will increase at 10% per annum for six years. Dollar costs will not change. At the end of six years Dzell’s patent expires and it will no longer export to Brazil. After the reais is devalued to R$4.00/US$ no further devaluation is expected. 
If Dzell raises the price in reais so as to maintain its dollar price, volume will increase at only 4% per annum for six years, starting from the lower initial base of 40,000 units. Again dollar costs will not change, and at the end of six years Dzell will stop exporting to Brazil. Dzell’s weighted average cost of capital is 12%. Given these considerations, what do you recommend for Dzell’s pricing policy? Justify your recommendation.
	
	
	
	
	
	
	
				Assumptions		Value
				Initial sales volume		* 50,000
				Sales volume growth		10%
				Sales price, US$		$170.00
				Direct cost per unit		$120.00
	
		Alternative #1: Maintain current Brazilian sales price and volume grows 10% per annum
		End								Contribution		12%
		of year		Sales volume		US$ Revenue		Direct Costs		Margin		PV Factor		Present Value
		1		* 50,000		$8,500,000		$6,000,000		$2,500,000		* 0.8929		$2,232,143
		2		* 55,000		$9,350,000		$6,600,000		$2,750,000		* 0.7972		$2,192,283
		3		* 60,500		$10,285,000		$7,260,000		$3,025,000		* 0.7118		$2,153,135
		4		* 66,550		$11,313,500		$7,986,000		$3,327,500		* 0.6355		$2,114,686
		5		* 73,205		$12,444,850		$8,784,600		$3,660,250		* 0.5674		$2,076,924
		6		* 80,526		$13,689,335		$9,663,060		$4,026,275		* 0.5066		$2,039,836
	
										Present value of contribution margins				$12,809,008
	
	
				Assumptions		Value
				Initial sales volume		* 40,000
				Sales volume growth		4%
				Sales price, US$		$200.00
Direct cost per unit		$120.00
	
		Alternative #2: Raise Brazilian sales price to R$400 and volume grows only 4% per annum from a lower volume base
		End								Contribution		12%
		of year		Sales volume		US$ Revenue		Direct Costs		Margin		PV Factor		Present Value
		1		* 40,000		$8,000,000		$4,800,000		$3,200,000		* 0.8929		$2,857,143
		2		* 41,600		$8,320,000		$4,992,000		$3,328,000		* 0.7972		$2,653,061
		3		* 43,264		$8,652,800		$5,191,680		$3,461,120		* 0.7118		$2,463,557
		4		* 44,995		$8,998,912		$5,399,347		$3,599,565		* 0.6355		$2,287,589
		5		* 46,794		$9,358,868		$5,615,321		$3,743,547		* 0.5674		$2,124,189
		6		* 48,666		$9,733,223		$5,839,934		$3,893,289		* 0.5066		$1,972,462
	
										Present value of contribution margins				$14,358,000
	
		Alternative #2 is preferable, yielding a higher present value of total contribution margin over the expected remaining life of the export sales.
Pbm12.10
	
		Problem 12.10 Risk-Sharing at Harley Davidson
	
		Harley-Davidson (U.S.) reportedly uses risk-sharing agreements with its own foreign subsidiaries and with independent foreign distributors. Because these foreign units typically sell to their local markets and earn local currency, Harley would like to ease their individual currency exposure problems by allowing them to pay for merchandise from Harley (U.S.) in their local functional currency. 
The spot rate between the U.S. dollar and the Australian dollar on January 1 is A$1.2823/US$. Assume that Harley uses this rate as the basis for setting its central rate or base exchange rate for the year at A$1.2800/US$. Harley agrees to price all contracts to Australian distributors at this exact exchange rate as long as the current spot rate on the order date is within ±2.5% of this rate. If the spot rate falls outside of this range, but is still within ±5% of the central rate, Harley will "share" equally (i.e., "50/50") the difference between the new spot rate and the neutral boundary with the distributor.
	
	
	
	
	
	
	
	
	
	
	
		Assumption Set		Value
		Spot rate, central rate, A$/US$		* 1.2823
		Fixed rate zone, percent from central rate		2.500%
		Sharing zone boundaries, percent from central rate		5.000%
	
		a. Fixed Rate & Risk Sharing Zones
	
		Sharing Zone: upper boundary		* 1.2212		5.00%
	
		Fixed rate: upper boundary		* 1.2510		2.50%
	
		CENTRAL RATE		* 1.2823
	
		Fixed rate: lower boundary		* 1.3152		-2.50%
	
		Sharing Zone: lower boundary		* 1.3498		-5.00%
	
		If the spot rate falls between the fixed rate boundaries, the company guarantees its distributors prices in their local curency calculated using the central rate.
	
	
		If the spot rate falls between the fixed rate upper boundary and the sharing zone upper boundary, the company will "share" the exchange rate risk with the distributor. It calculates the effective rate as the fixed rate upper boundary + (0.5 x (spot - 1.2571)).
	
	
	
		If the spot rate falls between the fixed rate lower boundary and the sharing zone lower boundary, the company will "share" the exchange rate risk with the distributor. It calculates the effective rate as the fixed rate lower boundary + (0.5 x (spot - 1.3895)).
	
	
	
		b. If Harley ships a hog costing US$8,500, and the spot exchange rate on the order date is A$1.3442/US$,
		what is the price to the Australian dealership?
	
		The spot rate falls between the fixed rate lower boundary and the sharing zone lower boundary.
		This means that the effective rate is a "shared rate":
	
		Spot rate, A$/US$		* 1.3442
		Fixed rate: lower boundary A$/US$		* 1.3152
		Difference, A$/US$		* 0.0290
	
		Effective rate = lower boundary + (.5 x (difference))		* 1.3297
	
		Hog price in US$		$8,500.00
		Effective exchange rate, A$/US$		* 1.3297
		Hog price to distributor, A$		* 11,302.36
	
		c. If Harley ships a hog costing US$8,500, and the spot exchange rate on the order date is A$1.2442/US$,
		what is the price to the Australian dealership?
	
		The spot rate falls between the central rate and fixed rate upper boundary, in the zone of fixed rate pricing.
		This means that the effective rate is the central rate.
	
		Hog price in US$		$8,500.00
		Effective exchange rate, A$/US$		* 1.2823
		Hog price to distributor, A$		* 10,899.55