Foreign exchange impacts the profitability of transactions in international markets. It can turn a profitable business into one that loses money and can turn an unprofitable business into one that makes money.
In this assignment, you will analyze the impact of foreign exchange on different business scenarios and present your findings in a short business memo.
You manage the international business for a manufacturing company. You are responsible for the overall profitability of your business unit. Your company ships your products to Malaysia. The retail stores that buy your products there pay you in their local currency, the Malaysian ringgit (MYR). All sales for the first quarter are paid on April 1st and use the exchange rate at the close of business on April 1st or the first business day after April 1st if it falls on a Saturday or Sunday. The company has sales contracts with different vendors that determine the number of units sold well in advance. The company is contractually obligated to sell 4,000 units for exactly 1.25 million MYR for the first quarter. The break-even point for each unit is $90 in U.S. dollars. Use the following foreign exchange rates:
On January 1, the daily spot rate is 3.13 MYR, and the forward rate is 0.317 U.S. dollars/MYR for April 1st of the same year.
On April 1, the daily spot rate is 3.52 MYR.
Using the information above, create a short business memo that explains the profitability, viability, and importance of considering foreign exchange on the basis of the scenarios below.
Scenario 1: The company uses the spot rate on April 1st to convert its sales revenue in MYR to U.S. dollars.
Scenario 2: On January 1st, the company uses that day’s forward rate today to lock in a foreign exchange rate for its expected 1.25 million MYR in sales. This means the company agreed to exchange 1.25 million MYR using the forward rate on January 1st when April 1 arrives.
Scenario 3: Another option for the company is to spend the foreign currency and avoid any currency exchange. Because it is a manufacturing company, raw materials are always needed.
Foreign Exchange Calculations: Determine the profitability of the international business by using foreign exchange calculations for the first and second scenarios.
Spend or Save: Discuss what you would need to consider when determining if the company should buy raw materials with the foreign currency in an effort to avoid foreign exchange risk and whether this is a viable option for the company.
Conclusion: After determining the result for each scenario, explain the importance to a company’s financial results of considering foreign exchange risk.
Answer & Explanation
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