a. How much should Mauna Loa borrow in yen?
Mauna Loa receives cash collections of one hundred million yen per month. This is the source of repayment of any
balance sheet hedge. If Mauna Loa 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, Mauna Loa 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.
Problem 12.1 Mauna Loa Macadamia
Mauna Loa, a macadamia nut subsidiary of Hershey‘s with planations on the slopes of its namesake volcano 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 $9,600,000. Sales are
relatively equally distributed during the year. They show up as a ¥250,00,000 account receivable on Mauna Loa’s balance sheet.
Credit terms to each customer allow for 60 days before payment is due. Monthly cash collections are typically ¥100,000,000.
Mauna Loa would like to hedge its yen receipts, but it has too many customers and transactions to make it practical to sell each
receivable forward. It does not want to use options because they are considered to be too expensive for this particular purpose.
Therefore, they have decided to use a “matching” hedge by borrowing yen.
a. How much should Mauna Loa borrow in yen?
b. What should be the terms of payment on the yen loan?
Bottom Top
The allowable range of exchange rates is (Ps/$) 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/$) 1.50
DeMagistris’ share 0.75
Acuña’s share 0.75
Therefore, DeMagistris will use the following effective exchange rate after risk-sharing:
Problem 12.2 Acuña Leather Goods
a. If the exchange rate changes immediately to Ps6.00/$, what will be the dollar cost of 6 months of imports to
Pucini?
a. If the exchange rate changes immediately to Ps6.00/$, what will be the dollar cost of 6 months of imports to
b. At Ps6.00/$, what will be the peso export sales in Acuña Leather Goods to DeMagistris Fashion Company?
DeMagistris Fashion Company, based in New York City, imports leather coats from Acuña 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 DeMagistris and Acuña 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/$ DeMagistris will
pay based on the spot rate. If the exchange rate falls outside this range they will share the difference equally with Acuña
Leather Goods. The risk-sharing agreement will last for six months, at which time the exchange rate limits will be
reevaluated. DeMagistris contracts to import leather coats from Acuña for Ps8,000,000 or $2,000,000 at the current spot
rate of Ps4.0/$ during the next six months.
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.
Problem 12.3 Manitowoc Crane (A)
Manitowoc Crane (U.S.) 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, Manitowoc Crane 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.
a. What would be the short-run (one year) impact of each pricing strategy?
b. Which do you recommend?
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
19,000 $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 $296,903,613
Problem 12.4 Manitowoc Crane (B)
Manitowoc Crane is better off raising the Chinese sales price to maintain the US dollar price, and suffering the lower volumes. The volume decrease does not offset the stronger US dollar
price per unit received.
Assume the same facts as in Manitowoc Crane (A). Additionally, financial management believes that if it maintains the same yuan sales price, volume will increase at 12% per annum for
eight years. Dollar costs will not change. At the end of ten years, Manitowoc’s patent expires and it will no longer export to China. After the yuan is devalued to Yuan9.20/$, no further
devaluations are expected. If Manitowoc Crane 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 Manitowoc Crane will stop exporting to China. Manitowoc’s weighted average cost of capital is
10%. Given these considerations, what should be Manitowoc’s pricing policy?
Assumptions Values
Invoice price of car £32,000
Spot exchange rate, NZ$/£ 1.6400
Risk-sharing band, percentage +/- 5.00%
Sales to New Zealand Distributors Lower Band Upper Band
b. Cost to the Kiwi distributor for 10 cars
New current spot rate (N$/£) 1.7000
Is this within the band? Yes
Cost of 10 cars at this exchange rate (NZ$) 544,000
Receipts to MacLoren in British pounds £320,000
(Within the band MacLoren receives £12,000/car, as expected)
c. Cost to the Kiwi distributor for 10 cars
New current spot rate (N$/£) 1.6500
Is this within the band? Yes
Cost of 10 cars at this exchange rate (NZ$) 528,000
Problem 12.5 MacLoren Automotive
MacLoren Automtive 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 MacLoren models unless MacLoren
could share some of the foreign exchange risk. MacLoren 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, MacLoren 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/£.
a. What are the outside ranges within which the New Zealand importer must pay at the then current spot rate?
b. If MacLoren ships 10 sports cars to the New Zealand distributor at a time when the spot exchange rate is
NZ$1.7000/£, and each car has an invoice cost £32,000, what will be the cost to the distributor in New Zealand
dollars? How many pounds will MacLoren receive, and how does this compare with McLaren’s expected sales receipt
of £32,000 per car?
c. If MacLoren Automotive ships the same 10 cars to New Zealand at a time when the spot exchange rate is
NZ$1.6500/£, how many New Zealand dollars will the distributor pay? How many pounds will MacLoren Automotive
receive?
d. Does a risk-sharing agreement such as this one shift the currency exposure from one party of the transaction to the
other?
e. Why is such a risk-sharing agreement of benefit to MacLoren? To the New Zealand distributor?
Receipts to MacLoren in British pounds £320,000
(Within the band MacLoren receives £12,000/car)
d. How does this shift the currency risk?
e. Who benefits from this risk-sharing agreement?
Both parties in practice. The manufacturer has predictable revenues within the range, while the distributor bears a
moderate level of currency risk within the 5% range. The distributor will hopefully be able to provide a more stable
pricing to pass on to the customer, which will also benefit the manufacturer through a more stable and sustinable
distributor sales outlet.
MacLoren bears no risk within the 5% range. The distributor carries all of the risk within 5%. If the exchange rate falls
outside the 5% range, MacLoren shares the risk with the distributor.
Assumptions 2014 2015 2016 2017 2018
Sales volume (units) 1,000,000 1,000,000 1,000,000 1,000,000 1,000,000
Sales price per unit € 12.80 € 12.80 € 12.80 € 12.80 € 12.80
Direct cost per unit € 9.60 € 9.60 € 9.60 € 9.60 € 9.60
German corporate tax rate 29.5% 29.5% 29.5% 29.5% 29.5%
Exchange rate ($/€) 1.0000 1.0000 1.0000 1.0000 1.0000
Income Statement 2014 2015 2016 2017 2018
Sales revenue € 12,800,000 € 12,800,000 € 12,800,000 € 12,800,000 € 12,800,000
Direct cost of goods sold -9,600,000 -9,600,000 -9,600,000 -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 € 1,710,000 € 1,710,000 € 1,710,000
Income tax expense -504,450 -504,450 -504,450 -504,450 -504,450
Net income € 1,205,550 € 1,205,550 € 1,205,550 € 1,205,550 € 1,205,550
Operating Cash Flows
Net income € 1,205,550 € 1,205,550 € 1,205,550 € 1,205,550 € 1,205,550
Add back depreciation 600,000 600,000 600,000 600,000 600,000
Changes in net working capital 0 0 0 0 0
Cash flow from operations € 1,805,550 € 1,805,550 € 1,805,550 € 1,805,550 € 1,805,550
Net Working Capital Calculations
A/P 1,332,603 1,332,603 1,332,603 1,332,603 1,332,603
Net Working Capital 508,493 508,493 508,493 508,493 508,493
Using the Ganado Germany analysis in Exhibit 12.5 and 12.6 where the euro depreciates, how would prices, costs, and volumes change if Ganado
Germany was operating in a nearly purely domestic, mature market, with major domestic competitors?
If all competitors were domestic, Ganado Germany could not change price to try and pass-through exchange rate changes. As a result, all of its
operating parameters would remain the same, but its value would fall when valued in U.S. dollars by its U.S. parent company. This is the same as
Case 1 in the chapter discussion.
Exhibit 12.6 Ganado Germany — All Domestic Competitors
Assumptions 2014 2015 2016 2017 2018
Sales volume (units) 1,400,000 1,400,000 1,400,000 1,400,000 1,400,000
Sales price per unit € 12.80 € 12.80 € 12.80 € 12.80 € 12.80
Direct cost per unit € 9.60 € 9.60 € 9.60 € 9.60 € 9.60
German corporate tax rate 29.5% 29.5% 29.5% 29.5% 29.5%
Exchange rate ($/€) 1.0000 1.0000 1.0000 1.0000 1.0000
Income Statement 2014 2015 2016 2017 2018
Sales revenue € 17,920,000 € 17,920,000 € 17,920,000 € 17,920,000 € 17,920,000
Direct cost of goods sold -13,440,000 -13,440,000 -13,440,000 -13,440,000 -13,440,000
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 € 2,990,000 € 2,990,000 € 2,990,000 € 2,990,000 € 2,990,000
Income tax expense -882,050 -882,050 -882,050 -882,050 -882,050
Net income € 2,107,950 € 2,107,950 € 2,107,950 € 2,107,950 € 2,107,950
Operating Cash Flows
Net income € 2,107,950 € 2,107,950 € 2,107,950 € 2,107,950 € 2,107,950
Add back depreciation 600,000 600,000 600,000 600,000 600,000
Changes in net working capital -203,397 0 0 0 0
Cash flow from operations € 2,504,553 € 2,707,950 € 2,707,950 € 2,707,950 € 2,707,950
Net Working Capital Calculations
A/P 1,865,644 1,865,644 1,865,644 1,865,644 1,865,644
Net Working Capital 711,890 711,890 711,890 711,890 711,890
Exhibit 12.7 Ganado Germany — All Foreign Competitors
Ganado Germany is now competing in a number of international (export) markets, growth markets, in which most of its competitors are foreign.
Now how would you expect Ganado Germany’s operating exposure to respond to the depreciation of the euro?
Ganado Germany would most likely try to profit from its now weak-currency home country (Germany), and would try and increase sales volumes
dramatically in a growth market by keeping the price in euros the same. The result is something like case 2 in the chapter discussion, where volume
could jump dramatically (thinking positive).
a. Assuming each Rolls-Royce engine marketed to Airbus costs £22.5 million each, how has the price of that engine changed over the period shown?
Date 1Q 2007 2Q 2007 3Q 2007 4Q 2007 1Q 2008 2Q 2008 3Q 2008 4Q 2008 1Q 2009 2Q 2009 3Q 2009 4Q 2009
Price (millions of pounds, £) £22.50 £22.50 £22.50 £22.50 £22.50 £22.50 £22.50 £22.50 £22.50 £22.50 £22.50 £22.50
Spot rate (euro = 1.00 pound) 1.4918 1.4733 1.4696 1.4107 1.3198 1.2617 1.2590 1.1924 1.1017 1.1375 1.1467 1.1066
Price (millions of euros, €)€ 33.57 € 33.15 € 33.07 € 31.74 € 29.70 € 28.39 € 28.33 € 26.83 € 24.79 € 25.59 € 25.80 € 24.90
b. What is the cumulative percentage change in the price of the engine in euros for the three year period?
Using the basic percentage change formula of (P2 – P1)/(P1), the percentage change is: -25.8%
d. Compare the prices and volumes for the first quarter of each of the three years shown. Who has benefited the most from the exchange rate changes?
1Q 2007 1Q 2008 1Q 2009 % Chg
Price (in millions of £)£22.50 £22.50 £22.50 0.0% The price of the RR engines as sold by RR is unchanged over the period.
Spot rate (€/£)1.4918 1.3198 1.1017 The British pound steadily weakened against the euro over the period.
Price (in millions of €)€ 33.57 € 29.70 € 24.79 -26.1% The price of each engine in euros fell 26%.
Sales volume (engines) 200 220 240 20.0% Engine sales volumes grew 20%.
Total cost to Airbus (millions of €)€ 6,713.10 € 6,533.01 € 5,949.18 -11.4% Total costs in euros to Airbus fell 11.4%.
Total revenue to RR (millions of £)£4,500.00 £4,950.00 £5,400.00 20.0% Total revenues accruing to RR rose 20%, equal to the volume growth.
If volumes had not grown, RR revenues would not have changed.
Clearly Airbus has captured the majority of the benefits as its cost per engine (-26.1%) and total costs of purchases have fell dramatically (-11.4%).
If the price inelasticity of demand is inelastic (ep < 1), then a large percentage change in the price — in this case in euros — does not generate an increase in sales quantity to offset the decline in price.
Problem 12.8 Rolls-Royce Turbine Engines
Rolls-Royce is struggling with its pricing strategy with a number of its major customers in Continental Europe, particularly Airbus. Since Rolls-Royce is a British company with most manufacturing of the Airbus engines in the United
Kingdom, costs are predominantly denominated in British Pounds. But in the period shown, 2007-2009, the pound steadily weakened against the euro. Rolls-Royce has traditionally denominated its sales contracts with Airbus in Airbus’
home currency, the euro.
c. If the price elasticity of demand for RR turbine sales to Airbus is relatively inelastic, and the price of the engine in British pounds never changes over the period, what does this price change mean for Rolls-Royce’s total
sales revenue on sales to Airbus of this engine?
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):
Alternative #2 is preferable. In the short run (one year), HP Products 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 HP Product’s
contribution margin is only $2,500,000. This is a short-run solution, and does not consider possible longer-run effects that might come from
raising the local price and/or accepting a smaller market share.
Problem 12.9 Hurte-Paroxysm Products, Inc. (A)
Hurte-Paroxysm Products, Inc. (HP) of the United States exports computer printers to Brazil, whose currency, the reais (symbol R$) 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, HP Products faces a pricing decision which must be made before any
actual devaluation: HP Products 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?
Assumptions Value
Initial sales volume 50,000
Sales volume growth 10%
Sales price, US$ $170.00
Direct cost per unit $120.00
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 $2,114,686
Sales volume growth 4%
Sales price, US$ $200.00
Direct cost per unit $120.00
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
Problem 12.10 Hurte-Paroxysm Products, Inc. (B)
Assume the same facts as in Hurte-Paroxysm Products, Inc. (A). HP Products 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 HP Products’ 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 HP Products 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 HP
Products will stop exporting to Brazil. HP Products’ weighted average cost of capital is 12%. Given these considerations, what do you recommend for HP Products’
pricing policy? Justify your recommendation.
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.