Question

1. Consider a US company that imports German goods. What effect will a sudden depreciation of the dollar relative to the euro have on the P/E ratio of the U.S. company? Discuss the effect both the possibilities—the company being able to completely pass through the dollar depreciation to its customers and the company being unable to completely pass through the dollar depreciation to its customers. (5 points)

Answer 1

Given that the company is importing German goods. If there is a depreciation of the dollar relative to the euro, there needs to be more dollar sold to buy the same amount of euro for importing. This would mean that the company's US dollar profit would decline thus ending with lowering future earnings. Given there is nor change in the price of the stock, the forward Price to earnings ratio will increase as a result of sudden depreciation. However, the trailing PE remains unchanged if the price is constant.

If the company enters into a contract such as options or forward contracts to completely mitigate the risk to customers and completely pass through the depreciation, then the customers can buy the goods at the same price as they have quoted earlier. If however, the importer is unable to pass through the dollar depreciation, then the customers will have to pay a higher price for the goods to offset for the depreciation.