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A B C D E F G H I J
Solution 12/8/2012
Chapter: 17
Problem: 15
You will find Tables 17-1, 17-2, and 17-3 useful for this problem.
TABLE 17-1
Exchange rates of select major currencies, relative to the U.S. dollar
Note: only blue cells need to be updated with current quotes.
Direct Indirect
Quotations Quotations
(1) (2)
Canadian dollar 0.9783 1.0222
Japanese yen 0.0127 79.0100
Key Currency Cross-Exchange Rates
Note: these do not need to be updated because they are derived from the quotes in Table 17-1 and are not rounded.
Dollar Euro Pound SFranc Peso Yen CdnDlr
Canada 1.0222 1.3064 1.6170 1.0877 0.0740 0.0129 ....
Japan 79.0100 100.9748 124.9859 84.0711 5.7196 .... 77.2941
Input Data
Cost of rosewood and mahogany (pesos) 2,750
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
distributer in Mexico, spruce harvested in and imported from Canada, and ebony and the electronics imported from a
Japanese distributer. Other parts are obtained in the U.S. When broken down on a per-guitar basis, the component and
finishing costs are as follows:
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?
Note: The pound and euro are quoted as direct quotations. Other currencies are quoted as indirect quotations. Blue
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A B C D E F G H I J
Sale price of the MC-28 (pounds) £1,600
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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 0.0724
Cost of rosewood and mahogany in $ = $199.07
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
TOTAL COST OF THE MC-28 (in dollars) = $1,151.67
MC-28 SALES PRICE (in dollars) = $2,531.04
b. What is the dollar profit that Collins makes on the sale of the MC-28? What is the percentage profit?
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
The percentage profit is determined as the dollar profit divided by the total cost.
% profit = $ profit ÷ Total cost
-10%
We will reproduce the table from the top of the spreadsheet, but we will add a column for the new exchange rates.
c. If the U.S. dollar were to depreciate by 10% against all foreign currencies, what would the dollar and percentage
profits be for the MC-28?
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).
Change in dollar versus all currencies (positive is
appreciation, negative is depreciation):
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A B C D E F G H I J
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)
Spruce
Cost of spruce in $ = Cost in CdnDlr x Direct spot exchange rate ($/CdnDlr)
Cost of spruce in $ = 200.00 x 1.0870
Cost of spruce in $ = $217.40
Ebony and electronics
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
TOTAL COST OF THE MC-28 (in dollars) = $1,212.97
Revenue from sale of the MC-28 in England
MC-28 SALES PRICE (in dollars) = $2,812.27
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A B C D E F G H I J
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 = $2,812.27 - 1,212.97
Dollar profit = $1,599.30
The percentage profit is determined as the dollar profit divided by the total cost.
Change in dollar strength against the pound -10%
Direct Indirect
Quotations Quotations
(1) (2)
Canadian dollar 0.9782821 1.02220 0.97828
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)
Spruce
Cost of spruce in $ = Cost in CdnDlr x Direct spot exchange rate ($/CdnDlr)
Cost of spruce in $ = 200.00 x 0.9783
Cost of spruce in $ = $195.66
TOTAL COST OF THE MC-28 (in dollars) = $1,151.67
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 1.75767
Sale price (in $) = $2,812.27
MC-28 SALES PRICE (in dollars) = $2,812.27
be the case.
d. If the U.S. dollar were to depreciate by 10% only against the pound and remained constant relative to all other foreign
currencies, what would the dollar and percentage profits be for the MC-28?
Since dollar is depreciating relative to the pound, a dollar buys fewer pounds than before its depreciation. Therefore, the
New Indirect
Quotations
(3)
New Direct
Quotations
(4)
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The dollar profit from the sale of the MC-28 is simply the sales revenue minus the total cost.
Applying interest rate parity, we can determine the return on 90-day securities in England.
TABLE 17-3 (abridged)
Forward exchange rates for the British pound
Spot Rate 30 days 90 days 180 days
British Pound 0.6322 0.6323 0.6325 0.6328 Note: these are direct quotes.
Purchasing power parity allows us to establish the following problem.
e. Using the forward exchange information from Table 17-3, calculate the return on 90-day securities in England, if the
rate of return on 90-day securities in the U.S. is 3.9%.
Because sales are made in pounds, dollar revenues increase when the dollar depreciates relative to the pound--there are
fewer pounds per pound, but there are more dollars per pound.
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.)
Forward Rates
