In: Finance
A firm can produce orange juice in the US and ship it to Japan at a cost of $1.75/unit. They want to sell it with a 50% markup (50% higher than their cost), and the yen/US$ exchange rate is 111.11.
1) At what price would they sell it in Japan (in yen)?
2)What is their US$ profit?
Now suppose the $ appreciates from ¥/US$ 111.11 to ¥120/US$ prior to payment.
3) What is the new US$ revenue and profit?
4) How does it compare with what the company was expecting?
5) What might the company have done to protect itself?
1) Here cost = $1.75 per unit
Now firm wants 50% marke up, hence selling price = 1.75 x (1+50%)
=1.75(1.5)
=2.625$ per unit
Selling price in Japan can be derieved using yen/US $ exchange rate
1$ = 111.11 yen
2.625$ = ?
= 2.625 x 111.11
=291.66 yen
2) US $ Profit = Selling price per unit - cost per unit
=2.625$ -1.75$
= 0.875$ per unit
3) Suppose the $ appreciates from ¥/US$ 111.11 to ¥120/US$ prior to payment ,them form will receive sales revemue as below
1$ = 120 Yen
? = 291.66 yen
=291.66 /120
=2.43 $
Thus firm will receive only 2.43$ because of appreciation of yen
Thus Revenue = $2.43 per unit
Profit = Selling price per unit - cost per unit
=2.43$ -1.75$
= 0.68$ per unit
4) Revenue of the firm was expected as $ 2.625 while it was only able to realise $2.43 per unit thus from expectation it received 0.195$ less and Profit of firm was expected as 0.875$ per unit however it turned out to be only $0.68 per unit, thus decline of $ 0.195 per unit
5) Here firm was facing risk that the foreign currency (in our case yen) might appreciate to protect it self from this risk firm could have bought forward contract on YEN or bought call option on YEN