East Coast Yachts Goes International

Larissa Warren, the owner of East Coast Yachts, has been in discussion with a
yacht dealer in Monaco about selling the company’s yachts in Europe. Jarek Jachowitcz,
the dealer, wants to ass 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 Jerek 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 EastCoast 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 $0.65/€.
At this exchange rate, the company would spend 70 percent of the sales income on
production costs. The 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 the cons of the international sales plan? What additional risks
will the company face?

The pros of the international sales plan are that the company may gain profits due to the
effect of strengthening of the dollar.

The cons of the international sales plan are that the company has to consider the political
risks and different currency denominations. Language and cultural differences is critical
in all business transactions. Also, different countries have unique cultural heritages that
shape values and influence the conduct of business.

Additionally, each country has its own unique economic and legal systems, and these
differences can cause significant problems when a corporation tries to coordinate and
control its worldwide operations. For example, differences in tax laws among countries
can cause a given economic transaction to have strikingly different after-tax
consequences, depending on where the transaction occurs.

2. What happens to the company’s profits if the dollar strengthens? What if the dollar
weakens?

If the dollar strengthens, the price in Euro goes up. This means that the company’s yachts
price in Europe will go up. Therefore, to sell the yacht at such a high price will give the
company greater profit. The opposite goes to when 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 $0.55/€? What happens to profits if
the exchange rate changes to $0.75/€? At what exchange rate will the company break
even?

Sales: 1.20 * 5 m = $6,000,000

Commission: $6,000,000 * 0.05 = $300,000
Production cost: 1.20 * 5m = $6,000,000; 0.7 * $6,000,000 = $4,200,000

Therefore, the projected gains or losses are $6,000,000 - $300,000 - $4,200,000 =

$1,500,000 (a gain)

If the exchange rate changes to $1.30/€:

Sales: 1.30 * 5 m = $6,500,000

Commission: $6,500,000 * 0.05 = $325,000
Production cost: 1,20 * 5m = $6,000,000; 0.7 * $6,500,000 = $4,550,000

Therefore, the projected gains or losses are $6,500,000 - $325,000 - $4,550,000 =

$1,625,000 (a gain)

When the exchange rate changes to $1.30/€, the company’s profit increases from
$1,500,000 to $1,625,000.

The exchange rate at which the company break even:

Breakeven sales = Fixed costs / (unit contribution as a % if sales) = $325,000 /

($4,550,000 / $6,500,000) = $464,286.

Therefore, the exchange rate will be $464,286/ 1.30 = €357,143

$464,286/ €357,143
= $1.30/€

4. How could the company hedge its exchange rate risk? What are the implications for
this approach?

The company can hedge its exchange rate risk through forward markets. Another way is
to match up of foreign currency-denominated assets and liabilities. Also, the firm can
borrow in the foreign country. Fluctuations in the value of the foreign subsidiary’s assets
will then be at least partially offset by changes in the value of the liabilities.

The implications of these approaches are that, the company can be able to control the
day-to-day fluctuations in exchange rates. The company can also control fluctuation in
the value of a foreign operation due to unanticipated changes in relative economic
conditions.
5. Taking all factors into account, should the company pursue international sales further?
Why or why not?

Since the company will gain profits from this operation, they should pursue international
sales.

However, since “Jarek Jachowitcz, the dealer, wants to ass East Coast Yachts to his
current retail line”, it shows that this is the first time for the company to do a business
with this foreign company. Therefore, East Coast Yachts must take into consideration the
culture heritage of doing business in Europe.