Scenario:
Laura Watkins, the owner of Yakima Yachts, has been in discussions with a yacht dealer in Monaco about selling the company’s yachts in Europe. Rudolf Ranier, the dealer, wants to add Yakima Yachts to his current retail line. Rudolf has told Laura that he feels the retail sales will be 8 million euros (€) per month. All sales will be made in euros, and Rudolf will retain 5% of the retail sales as commission, which will be paid in euros. Because the yachts will be customized to order, the first sales will take place in one month. Rudolf will pay Yakima Yachts for an order 90 days after the customer takes delivery. This payment schedule will continue for the length of the contract between the two companies.
Laura is confident that the company can handle the extra volume with its existing facilities, but she is unsure about any potential financial risks associated with selling yachts in Europe. The current exchange rate is $1.34 per Euro ($1.34/€). At this exchange rate, the company would spend 80% of the sales income on production costs. This number does not reflect the sales commission to be paid to Rudolf.
Laura has decided to ask Doug Irwin, the company’s financial analyst, to prepare an analysis of the proposed international sales. Specifically, she is asking Doug to address the following questions:
Questions:
1. What are the pros and cons of the international sales plan? What additional risks will the company face?
2. What will happen to the company’s profits if the dollar strengthens? What if the dollar weakens?
3. Ignoring taxes, what are Yakima Yachts’ projected gains or losses from this proposed arrangement at the current exchange rate of $1.34/€? What will happen to profits if the exchange rate changes to $1.25/€? At what exchange rate will the company break even?
4. How can the company hedge its exchange rate risk? What are the implications of this approach?
5. Taking all factors into account, should the company pursue this proposal further? Why or why not?