Verizon Phone Company, an American firm, is estimating their profit in Germany f

Question

Verizon Phone Company, an American firm, is estimating their profit in Germany for next year. They are predicting sales in Germany of 200,000 units at 89 euros per unit. Their variable costs are 35 euros per unit and their fixed costs are 6,000,000 euros. Additionally, the tax rate that is to be paid to the German government is 30%. Assume there are no other charges to the company. a) what is the predicted net income in Euros? b) if the prediction changes to 250,000 units of sales, how will this change the predicted net income? (all the other data remains unchanged)? c) if the prediction decreases to 230,000 units of sales and the variable costs increase to 38 euros per unit, how will this change the predicted net income (all the other data remains unchanged)? d) The net income for this German unit will be reported on 12/31 and then the profits need to be translated back to the United States. What is the risk in this situation and how can the American parent decrease this risk?

Explanation / Answer

a) Predicted Net Income in Euros = {[200000 * (89-35)] - 6000,000} * 0.70 = 3,360,000 euros

b) Units sold = 250000, Predicted Net Income in Euros = {[250000 * (89-35)] - 6000,000} * 0.70 = 5,250,000 euros

c) Units sold = 230000 and Variable costs = 38 euros, Predicted Net Income in Euros = {[230000 * (89-38)] - 6000,000} * 0.70 = 4,011,000 euros

d) When the profits need to be translated back to the United States, the Dollar-Euro exchange rate will create the risk. This risk can be reduced by hedging the future position equivalent to expected profit in euros. It will have some cost but will deprive you with heavy exchange rate losses.

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