Question

Exhibit 1: Pre-Brexit Income Statement, Assuming £1.00 = €1.36

	Per Unit	Quantity (Units)	€	£
Sales in the U.K.	£200	40,000		8,000,000
U.K. Costs
Contract Labor (variable cost £5 each)	£5	40,000		200,000
Import of Coffee Machines (invoiced at €90 each)	€90	40,000	3,600,000	2,647,059
Marketing and Distribution Costs (Fixed costs)				400,000
Other Fixed Costs: Overheads, Interest, Depreciation, Rent, Salaries, etc.				500,000
Profit (U.K. Subsidiary)				£4,252,941 (€5,784,000)

1. Recalculate the income statement above using the post Brexit exchange rate of £00 = €1.16, assuming that there are no changes in prices charged by the company to U.K. buyers. Calculate profits in both pounds and euros. Fill out Exhibit 2 below with your answers:

Exhibit 2: Post-Brexit Income Statement, Assuming £1.00 = €1.16, no change in prices

	Per Unit	Quantity (Units)	€	£
Sales in the U.K.	£200
U.K. Costs
Contract Labor (variable cost £5 each)	£5
Import of Coffee Machines (invoiced at €90 each)	€90
Marketing and Distribution Costs (Fixed costs)				400,000
Other Fixed Costs: Overheads, Interest, Depreciation, Rent, Salaries, etc.				500,000
Profit (U.K. Subsidiary)

2. The VRA consultants argued that there were two potential price elasticities of demand: e_p =- 0.8 and e_p = -1.1
   1. Why are there two different potential numbers? Which seems the most realistic to you? Explain.
   2. If e_p   = -.8, should Molto Delizioso raise prices, lower prices, or keep them the same? Explain.
   3. If e_p = -1.1, and Molto Delizioso raises its prices to £235, will this increase or decrease revenue? Explain.

3. Assume that marginal costs are constant and equal to variable costs.
   1. What is the optimal markup over costs if e_p =- 1.1?
   2. What is the optimal price if e_p =- 1.1?
   3. Fill out Exhibit 3 below using the optimal price and compare profits to Exhibit 1 & 2. Estimate quantity demanded with Table 1 below.
   4. Reflect on your results under this pricing strategy.
      1. Is your result realistic?
      2. What is the primary assumption it is relying on?
      3. What do you think would happen if you set this specific price? What things might undermine the assumptions that you are working under?
      4. Ultimately, given the information from the case and your knowledge of the economics of pricing and exchange rates, what price would you set? Explain.

Exhibit 3: Post-Brexit Income Statement, Assuming £1.00 = €1.16, optimal price with e_p =- 1.1

	Per Unit	Quantity (Units)	€	£
Sales in the U.K.	£
U.K. Costs
Contract Labor (variable cost £5 each)	£5
Import of Coffee Machines (invoiced at €90 each)	€90
Marketing and Distribution Costs (Fixed costs)				400,000
Other Fixed Costs: Overheads, Interest, Depreciation, Rent, Salaries, etc.				500,000
Profit (U.K. Subsidiary)

Answer 1

EXIBIT 1: PREBREXIT INCOME STATEMENT ( ANNUALISED)
Particulars	Per Unit	Quantity(Units)	Currency in Euro	Currency in UK
Sales in UK	200	40000		8000000
Uk Costs
Contract labour				200000
Import of Coffee machines (invoiced at 90 euro each)	90	40000	3600000	2647059
Marketing & distribution cost				400000
Other fixed cost				500000
Profit (UK subsidiary)				4252941	UK
				5784000	EURO

Scenario#2

Here price elasticity is 1:1 & price increases from 200 to 235 i.e 17.5%, so demand by 17.5% and total quantity is 47000. EXIBIT 1: PREBREXIT INCOME STATEMENT ( ANNUALISED) Particulars Per Unit Quantity(Units) Currency in Euro Currency in UK Sales in UK 235 47000 11045000 Uk Costs Contract labour 200000 Import of Coffee machines (invoiced at 90 euro each) 90 47000 4230000 3646552 Marketing & distribution cost 400000 Other fixed cost 500000 Profit (UK subsidiary) 6298448 UK 7306200 EURO Scenario #3 Here elasticity is 0.8:1 & price increases @17.5%, so demand decreases by %change in quantity demanded /%age change in price =x/1.175=.8 Here Xis    1.175*.8= 0.94 = 40000*.94 = 37600 EXIBIT 1: PREBREXIT INCOME STATEMENT ( ANNUALISED) Particulars Per Unit Quantity(Units) Currency in Euro Currency in UK Sales in UK 235 37600 8836000 Uk Costs Contract labour 200000 Import of Coffee machines (invoiced at 90 euro each) 90 37600 3384000 2917241 Marketing & distribution cost 400000 Other fixed cost 500000 Profit (UK subsidiary) 4818759 UK 5589760 EURO