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b) FLAME FIXTURES INC. Business Application of Purchasing Power Parity Flame Fixtures Inc. is a small U.S. business in Arizona that produces and sells lamp

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b) FLAME FIXTURES INC. Business Application of Purchasing Power Parity Flame Fixtures Inc. is a small U.S. business in Arizona that produces and sells lamp fixtures. Its costs and its revenues have been very stable over time. In; profits have been adequate, but Flame has been searching for means of increasing profits in the future. It has recently been negotiating with a Mexican firm called Caron' Company; from which it would purchase some of the necessary parts. Every three months Caron' Company would send a specified number of parts with the bill invoiced in Mexican pesos. By having the paris produced by Caron', the company is expected to save about 20 percent on production costs. Caron' is only willing to work out a deal if it is assured that it will receive a minimum specified amount-of orders every three months over the next ten years, for a minimum specified amount. Flame will be required to use its assets to serve as collateral in case it does not fulfill its obligation. The price of the parts will change over time. in response to.the costs of production. Flame recognizes that the cost to Caron' will increase substantially over time, as a result of the very high inflation rate in Mexico. Therefore. the price charged in pesos will likely rise substantially every three months. However, Flame feels that because of the concept of purchasing power parity (PPP), its dollar payments to Caron' will be very stable. According to PPP. if Mexican inflation is much higher than US. inflation, the peso will weaken against the dollar by that difference. Since Flame does not have much liquidity. it could experience a severe cash shortage if its expenses were much higher than anticipated. The demand -for Flame's product has been very stable. and is expected to continue that way. Since the U.S. ination rate is expected to be very low, Flame will likely continue pricing its lamps at today's prices (in dollars). It believes that by saving 20 percent on production costs, it will substantially increase its profits. It is about ready to sign a contract with Caron' Company. a) Describe a scenario that could cause Flame to save even more than 20 percent on production costs. Describe a scenario that could cause Flame to actually incur higher production costs than if it simply had the parts produced -In the U.S. Do you think that Flame will experience stable dollar outflow payments to Caron' over time? Explain. (Assume that the number of parts ordered is constant over time). d) Do you think that Flame's risk changes at all as a result of its new relationship with Coron' Company? Explain

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