Larissa Warren, the owner of East Coast Yachts, has been in discussions with a yacht dealer in Monaco about selling the company’s yachts in Europe. Jarek Jachowicz, the dealer, wants to add East Coast Yachts to his current retail line. Jarek has told Larissa that he feels the retail sales will be approximately €5 million per month. All sales will be made in euros, and Jarek will retain 5 percent of the retail sales as commission, which will be paid in euros. Since the yachts will be customized to order, the first sales will take place in one month. Jarek will pay East Coast Yachts for the order 90 days after it is filled. This payment schedule will continue for the length of the contract between the two companies. Larissa is confident the company can handle the extra volume with its existing facilities, but she is unsure about any potential financial risks of selling its yachts in Europe. In her discussion with Jarek, she found that the current exchange rate is $.78/€. At this exchange rate, the company would spend 70 percent of the sales income on production costs. This number does not reflect the sales commission to be paid to Jarek. Larissa has decided to ask Dan Ervin, the company’s financial analyst, to prepare an analysis of the proposed international sales. Specifically, she asks Dan to answer the following questions:
1. What are the pros and cons of the international sales plan? What additional risks will the company face?
2. What happens to the company’s profits if the dollar strengthens? What if the dollar weakens?
3. Ignoring taxes, what are East Coast Yachts’ projected gains or losses from this proposed arrangement at the current exchange rate of $.78/€? What happens to profits if the exchange rate changes to $.82/€? At what exchange rate will the company break even?
4. How could the company hedge its exchange rate risk? What are the implications for this approach?
5. Taking all factors into account, should the company pursue international sales further? Why or why not?