East Coast Yachts Goes International Larissa Warren, the owner of East Coast Yachts, has been in discussion with a yacht
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East Coast Yachts Goes International Larissa Warren, the owner of East Coast Yachts, has been in discussion with a yacht dealer in Monaco about selling the company’s yachts in Europe. Jarek Jachowitcz, the dealer, wants to ass East Coast Yachts to his current retail line. Jarek has told Larissa that he feels the retail sales will be approximately €5 million per month. All sales will be made in euros, and Jerek will retain 5 percent of the retail sales as commission, which will be paid in euros. Since the yachts will be customized to order, the first sales will take place in one month. Jarek will pay EastCoast Yachts for the order 90 days after it is filled. This payment schedule will continue for the length of the contract between the two companies. Larissa is confident the company can handle the extra volume with its existing facilities, but she is unsure about any potential financial risks of selling its yachts in Europe. In her discussion with Jarek, she found that the current exchange rate is $0.65/€. At this exchange rate, the company would spend 70 percent of the sales income on production costs. The number does not reflect the sales commission to be paid to Jarek. Larissa has decided to ask Dan Ervin, the company’s financial analyst, to prepare an analysis of the proposed international sales. Specifically, she asks Dan to answer the following questions: 1. What are the pros and the cons of the international sales plan? What additional risks will the company face? The pros of the international sales plan are that the company may gain profits due to the effect of strengthening of the dollar. The cons of the international sales plan are that the company has to consider the political risks and different currency denominations. Language and cultural differences is critical in all business transactions. Also, different countries have unique cultural heritages that shape values and influence the conduct of business. Additionally, each country has its own unique economic and legal systems, and these differences can cause significant problems when a corporation tries to coordinate and control its worldwide operations. For example, differences in tax laws among countries can cause a given economic transaction to have strikingly different after-tax consequences, depending on where the transaction occurs. 2. What happens to the company’s profits if the dollar strengthens? What if the dollar weakens? If the dollar strengthens, the price in Euro goes up. This means that the company’s yachts price in Europe will go up. Therefore, to sell the yacht at such a high price will give the company greater profit. The opposite goes to when the dollar weakens.
3. Ignoring taxes, what are East Coast Yachts projected gains or losses from this proposed arrangement at the current exchange rate of $0.55/€? What happens to profits if the exchange rate changes to $0.75/€? At what exchange rate will the company break even? Sales: 1.20 * 5 m = $6,000,000 Commission: $6,000,000 * 0.05 = $300,000 Production cost: 1.20 * 5m = $6,000,000; 0.7 * $6,000,000 = $4,200,000 Therefore, the projected gains or losses are $6,000,000 - $300,000 - $4,200,000 = $1,500,000 (a gain) If the exchange rate changes to $1.30/€: Sales: 1.30 * 5 m = $6,500,000 Commission: $6,500,000 * 0.05 = $325,000 Production cost: 1,20 * 5m = $6,000,000; 0.7 * $6,500,000 = $4,550,000 Therefore, the projected gains or losses are $6,500,000 - $325,000 - $4,550,000 = $1,625,000 (a gain) When the exchange rate changes to $1.30/€, the company’s profit increases from $1,500,000 to $1,625,000. The exchange rate at which the company break even: Breakeven sales = Fixed costs / (unit contribution as a % if sales) = $325,000 / ($4,550,000 / $6,500,000) = $464,286. Therefore, the exchange rate will be $464,286/ 1.30 = €357,143 $464,286/ €357,143 = $1.30/€ 4. How could the company hedge its exchange rate risk? What are the implications for this approach? The company can hedge its exchange rate risk through forward markets. Another way is to match up of foreign currency-denominated assets and liabilities. Also, the firm can borrow in the foreign country. Fluctuations in the value of the foreign subsidiary’s assets will then be at least partially offset by changes in the value of the liabilities. The implications of these approaches are that, the company can be able to control the day-to-day fluctuations in exchange rates. The company can also control fluctuation in the value of a foreign operation due to unanticipated changes in relative economic conditions.
5. Taking all factors into account, should the company pursue international sales further? Why or why not? Since the company will gain profits from this operation, they should pursue international sales. However, since “Jarek Jachowitcz, the dealer, wants to ass East Coast Yachts to his current retail line”, it shows that this is the first time for the company to do a business with this foreign company. Therefore, East Coast Yachts must take into consideration the culture heritage of doing business in Europe.