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A B C D E F G H I J
Solution 7/16/2015
Chapter: 17
Problem: 15
Mark Collins, luthier and businessman, builds and sells custom-made acoustic and electric stringed instruments.
Although located in Maryville, Tennessee, he purchases raw materials from around the globe. For example, his top-of-the
line acoustic guitar with onboard electronics, the MC-28, is constructed from rosewood and mahogany imported from a
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A B C D E F G H I J
Input Data
Cost of rosewood and mahogany (pesos) 2,750
Cost of spruce (CdnDlr) 200
Cost of ebony and electronics (yen) ¥12,400
Cost of parts and labor (U.S. dollars) $600
Sale price of the MC-28 (pounds) £1,600
We will convert the cost of each component to dollars, and find the total cost of the SY-20. We will do the same to find the
dollar sale price.
a. How much, in dollars, does it cost for Mark Collins to produce his MC-28? What is the dollar sale price of the MC-28
sold in England?
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Cost of parts and labor in $ = $600.00
TOTAL COST OF THE MC-28 (in dollars) = $1,036.13
Revenue from sale of the MC-28 in England
Sale price (in $) = Price in pounds x Direct spot exchange rate ($/pound)
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The dollar profit from the sale of the SY-20 is simply the sales revenue minus the total cost.
Dollar profit = Sales price −Total cost
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Cost of spruce in $ = 200.00 x 0.7822
Cost of spruce in $ = $156.45
Ebony and electronics
Cost of ebony and electronics in $ = Cost in yen x Direct spot exchange rate ($/yen)
Cost of ebony and electronics in $ = 12,400.00 x 0.0082
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A B C D E F G H I J
Rosewood and mahogany
Cost of rosewood and mahogany in $ = Cost in pesos x Direct spot exchange rate ($/peso)
Cost of rosewood and mahogany in $ = 2,750.00 x 0.0646
Cost of rosewood and mahogany in $ = $177.56
Spruce
Cost of spruce in $ = Cost in CdnDlr x Direct spot exchange rate ($/CdnDlr)
Cost of ebony and electronics in $ = $102.12
Parts and labor
Cost of parts and labor in $ = Cost in dollars
Cost of parts and labor in $ = 600.00
Sale price (in $) = 1,600 x 1.47440
Sale price (in $) = $2,359.04
MC-28 SALES PRICE (in dollars) = $2,359.04
Dollar profit = $2,359.04 −1,036.13
Dollar profit = $1,322.91
The percentage profit is determined as the dollar profit divided by the total cost.
We will reproduce the table from the top of the spreadsheet, but we will add a column for the new exchange rates.
Old Direct Old Indirect
Since dollar is depreciating, a dollar buys fewer units of foreign currency than before its depreciation. Therefore, the
indirect quotes (which show the number of units of foreign currency per dollar) should all be reduced by 10%. Then we
convert the new indirect quotes to direct quotes (divide 1 by an indirect quote to get a direct quote).
New Indirect
New Direct
profits be for the MC-28?
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Cost of parts and labor in $ = 600.00
MC-28 SALES PRICE (in dollars) = $2,621.16
A B C D E F G H I J
Cost of parts and labor in $ = Cost in dollars
Cost of parts and labor in $ = $600.00
TOTAL COST OF THE MC-28 (in dollars) = $1,084.59
Revenue from sale of the MC-28 in England
Quotations Quotations
(1) (2)
Canadian dollar 0.78223 1.27840 1.1506 0.8691
Japanese yen 0.00824 121.42000 109.2780 0.0092
Mexican peso 0.06457 15.48780 13.9390 0.0717
Swiss franc 0.99443 1.00560 0.9050 1.1049
British pound 1.47440 0.67824 0.6104 1.6382
Euro 1.04970 0.95265 0.8574 1.1663
Now, we will recompute the component costs and sales price of the MC-28.
Rosewood and mahogany
Cost of rosewood and mahogany in $ = Cost in pesos x Direct spot exchange rate ($/peso)
Cost of rosewood and mahogany in $ = 2,750.00 x 0.0717
Cost of rosewood and mahogany in $ = $197.29
Spruce
Cost of spruce in $ = Cost in CdnDlr x Direct spot exchange rate ($/CdnDlr)
Cost of spruce in $ = 200.00 x 0.8691
Cost of spruce in $ = $173.83
Ebony and electronics
Cost of ebony and electronics in $ = Cost in yen x Direct spot exchange rate ($/yen)
Cost of ebony and electronics in $ = 12,400.00 x 0.0092
Cost of ebony and electronics in $ = $113.47
Parts and labor
Quotations
(3)
Quotations
(4)
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Change in dollar strength against the pound -10%
The percentage profit is determined as the dollar profit divided by the total cost.
% profit = $ profit / Total cost
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Now, we will recompute the component costs and sales price of the MC-28.
Rosewood and mahogany
Cost of rosewood and mahogany in $ = Cost in pesos x Direct spot exchange rate ($/peso)
Cost of rosewood and mahogany in $ = 2,750.00 x 0.0646
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Cost of spruce in $ = $156.45
Ebony and electronics
Cost of ebony and electronics in $ = Cost in yen x Direct spot exchange rate ($/yen)
Cost of ebony and electronics in $ = 12,400.00 x 0.0082
Cost of ebony and electronics in $ = $102.12
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The dollar profit from the sale of the MC-28 is simply the sales revenue minus the total cost.
Dollar profit = Sales price – Total cost
Dollar profit = $2,621.16 – 1,084.59
Dollar profit = $1,536.57
% profit = $1,536.57 / 1,084.59
% profit = 141.67%
Japanese yen 0.0082359 121.42000 0.00824
Mexican peso 0.0645669 15.48780 0.06457
Swiss franc 0.9944312 1.00560 0.99443
British pound 1.4744 0.67824 0.6104 1.63822
Euro 1.0497 0.95265 1.04970
Cost of rosewood and mahogany in $ = $177.56
Spruce
Cost of spruce in $ = Cost in CdnDlr x Direct spot exchange rate ($/CdnDlr)
Cost of spruce in $ = 200.00 x 0.7822
Parts and labor
Cost of parts and labor in $ = Cost in dollars
Cost of parts and labor in $ = 600.00
Cost of parts and labor in $ = $600.00
The total costs go up because the dollar has depreciated against the currencies’ of the suppliers, making it more
expensive in dollars for Collins to purchase the raw materials. However, the depreciation of the dollar versus the pound
Since dollar is depreciating relative to the pound, a dollar buys fewer pounds than before its depreciation. Therefore, the
indirect quote for pounds (which shows the number of pounds per dollar) should be reduced by 10%. Then we convert
the new indirect quote to a direct quote (divide 1 by the indirect quote to get the direct quote). The is no need to change
any other direct quotes because the dollar is neither depreciation nor appreciating relative to them.
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Home nominal interest rate = 3.9%
Foreign nominal interest rate = 5.0%
Time to maturity on securities (in years) = 0.25
Home periodic interest rate = 0.975%
Foreign periodic interest rate = 1.250%
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Purchasing power parity allows us to establish the following problem.
f. Assuming that purchasing power parity holds, what would the sale price of the MC-28 be if it were sold in France
rather than England? (Hint: assume England is the home country.)
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( P f )
A B C D E F G H I J
TOTAL COST OF THE MC-28 (in dollars) = $1,036.13
Revenue from sale of the MC-28 in England
Sale price (in $) = Price in pounds x Direct spot exchange rate ($/pound)
Sale price (in $) = 1,600 x 1.63822
Sale price (in $) = $2,621.16
MC-28 SALES PRICE (in dollars) = $2,621.16
The dollar profit from the sale of the MC-28 is simply the sales revenue minus the total cost.
Dollar profit = Sales price – Total cost
Dollar profit = $2,621.16 – 1,036.13
Dollar profit = $1,585.03
The percentage profit is determined as the dollar profit divided by the total cost.
% profit = $ profit / Total cost
% profit = $1,585.03 / 1,036.13
% profit = 152.98%
Using knowledge of interest rate parity, the following problem is set up.
Spot exchange rate (direct quotation) = 1.4744
ft / (spot exchange rate) = [ (1+rh) / (1+rf) ]
ft = (spot exchange rate) [ (1+rh) / (1+rf) ]
ft = 1.4784
Price in pounds = 1,600
Exchange rate (pounds per euro) = 0.7120
P h= ( P f ) x ( e0 ) pounds per euro
(in pounds) 1,600 =
( P f ) x 0.71195
e. The rate of return on 90-day U.S. treasury securities is 3.9% and the rate of return on 90-day U.K. risk-free securities
is 5.0%. Using the spot exchange information from Table 17-1, estimate the 90-day forward exchange rate.