Question

1. Your firm has recently received an order for 500 units priced at $200 each from a distributor in Toronto (Canada). To fill the order, you have two options:
   1. Import polyester from a supplier in Monterrey (Mexico) to your manufacturing plant in Nashville (USA). Transform the polyester into carpet (1 unit of polyester = 1 unit of carpet), then transport the carpet to Toronto. Doing this comes at the following costs:
      1. Price of polyester from your Mexican supplier: 500 MEX (pesos) per unit.
      2. Transportation costs from Monterrey to Laredo (Texas):  38,000 MEX (pesos).
      3. Transportation costs from Laredo to Nashville: 3,000 USD (dollars).
      4. Transportation costs from Nashville to Detroit (Michigan):  1,000 USD (dollars).
      5. Transportation costs from Detroit to Toronto:  1,100 CAD (Canadian dollars).
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   2. Import polyester from a supplier in Toronto to your manufacturing plant in Nashville. Transform the polyester into carpet (1 unit of polyester = 1 unit of carpet), then transport the output back to Toronto. Doing this comes at the following costs:
      1. Price of polyester from your Canadian supplier: 50 CAD (Canadian dollars) per unit.
      2. Transportation costs from Toronto to Detroit: 1,100 CAD (Canadian dollars)
      3. Transportation costs from Detroit to Nashville: 1,000 USD (dollars).
      4. Transportation costs from Nashville to Detroit:  1,000 USD (dollars).
      5. Transportation costs from Detroit to Toronto:  1,100 CAD (Canadian dollars).

Assume the USD-MEX exchange rate is 1 USD = 19 MEX and the USD-CAD exchange rate is 1 USD = 1.24 CAD. Also assume it costs $10/unit to transform the polyester into carpet at your Nashville plant and there are no other associated costs. Which option is the best option? Compute total profits in US dollars for each option to justify your result.

Answer 1

Since the unit sale, sale price and transformation costs of polyester into carpet are same in both options, we can ignore them. We thus, just need to compare the total transportation costs of raw material and finished product to arrive at a conclusion.

Costs, Option a:

Polyester cost=500 Pesos X 500 units = 250000 Pesos = 250000/19=13157.89 Dollars

Transportation costs from Monterrey to Laredo (Texas):  38,000 MEX (pesos).=38000/19=2000 Dollars assuming this is total transportation cost and not transportation cost per unit of polyester.

Transportation costs from Laredo to Nashville: 3,000 USD (dollars).

Total raw material and raw material transportation costs = 13157.89+2000+3000=18157.89 Dollars

Transportation costs from Nashville to Detroit (Michigan):  1,000 USD (dollars).

Transportation costs from Detroit to Toronto:  1,100 CAD (Canadian dollars).= 1100/1.24 = 887.0968 US Dollars

Total Finished Product Transportation Costs = 1000+887.0968=1887.0968 Diollars

Total Costs for Option a = 18157.89 + 1887.0968 = 20044.99 Dollars

Similarly Costs for Option b are: 23935.48 Dollars

So Option a being of lower cost is more favourable.

Option a Profit =Sales - (Transformation cost + All other costs): Transformation Cost = 10 X 500 = 5000 Dollars + 20044.99 Dollars (Other Costs) = 25044.99 Dollars (Total Manufacturing & Delivery Costs)

Sales = 500 X 200 = 100000 Dollars

Thus, Option a Profit = 100000 Dollars - 25044.99 Dollars = 74955.01 Dollars

Similarly, Profit for Option b = 100000 - (5000 + 23935.48) = 100000 - 28935.48 = 71064.52 Dollars

Therefore confirmed that Option a is more favourable.