Advanced problem on pricing strategy. Dow of the United States makes bungee cords for sale in the United Kingdom. Dow charges $6 per cord, or £4 at the $1.50/£ spot rate. At this price, Dow expects annual sales of 20,000 cords in perpetuity. Variable costs are $3 per cord in the United States. The discount rate is i =

10 percent in each currency. (Recall that the value of a perpetuity is .) Dow is considering its price response to a 20 percent pound depreciation from , corresponding to a 25 percent dollar appreciation from .

a. Complete the following income statement and estimate Dow's value both in pounds and in dollars, assuming Dow maintains the £4 U.K. price and that sales volume in the United Kingdom does not change.

b. Elastic demand. Suppose Dow maintains the $6 (£5) price and U.K. sales falls by 50 percent. Complete the income statement at the end of this problem and estimate Dow's value in pounds and in dollars. What is Dow's optimal pricing strategy if demand is price elastic in this way?

c. Inelastic demand. Suppose Dow maintains the $6 (£5) price and U.K. sales volume falls by 10 percent. Complete the income statement below and estimate Dow's value in pounds and in dollars. What is Dow's optimal pricing strategy if demand is price inelastic in this way?

Income statement for problem 10.5, parts

(b) and (c):
20% pound depreciation from $1.50/£
to $1.20/£
Maintain $6 price

b. Elastic demand Sell 50% less

c. Inelastic demand Sell 10% less £ $ £ $
Price $6.00 $6.00 Cost $3.00 $3.00 Sales volume 10,000 10,000 18,000 18,000 Revenues $60,000 $108,000 COGS –30,000 –54,000 Taxable income 30,000 54,000 Tax (at 50%) –15,000 –27,000 Net cash flow 15,000 27,000 Tao's value (at i=10%)
$150,000 $270,000 Percentage change % –50% % –10%