Tuxedo Air Goes international
Mark Taylor and Jack Rodwell, the owners of Tuxedo Air, have been in discussions with a light aircraft dealer in Italy about selling the company's planes in Europe. Tracy jordon, the dealer, wants to add Tuxedo Air to his current retail line. Tracy has told mark and Jack that he feels the retail sales will be approximately E5.3million (Euro5.3million)per month. All sales will be made in euro, and tracy will retain 5% if retail sales as acommission, which will be paid i euros. Because the planes will be customized to order, the first sales will take place in one month. tracy will pay Tuxedo Air for the order 90 days after it is filled. This payment sechedulewill continue for the length of the contract between the two companies .
Mark and Jack are confident the company can handle the extra volume withits existing facilities , but they are unsure about the potential financial risks of selling their planes inEurope . In their discussion withTracy, they found that the current exchange rate is $1.37/EUR. At the current exchange rate, the company would spend 80% of the sales on production costs . This number does not reflect the sales commmission paid to Tracy.
Mark and Jack have decided to ask Ed Cowan , the company's financial anayst , to prepare an anaysis of the roposed international sales, specially, they ask Ed to answer the following questions
a. What happens to Tuxedo Air’s profits if the dollar strengthens against Euro? What if the dollar weakens?
b. Ignoring taxes, calculate Tuxedo Air’s projected gains or losses from this proposed arrangement at the current exchange rate of $1.35/EUR.
c. What happens to the company’s profits if the exchange rate changes to $1.12/EUR, assuming that operating costs are fixed regardless of the FX rate movements?
d. How would the company hedge its exchange rate risk using a forward contract with a forward rate of $1.25/EUR? What are the implications for this approach?