Company A, in the U.S, exports computer printers to Brazil, whose currency, the
ID: 2752944 • Letter: C
Question
Company A, in the U.S, exports computer printers to Brazil, whose currency, the reais (R$) has been trading at R$3.40/US$. Exports to Brazil are currently 50,000 printers per year at the reais equivalent of $200 each. A strong rumor exists that the reais will be devalued to R$4.00/US$ within two weeks by the Brazilian government. Should the devaluation take place, the reais is expected to remain unchanged for another decade. Accepting this forecasts as given, Company A faces a pricing decision which must be made before any actual devaluation; Company A may either 1) maintain the same reais price and in effect sell for fewer dollars, in which case Brazilian volume will not change, or 2) maintain the same dollar price, raise the reais price in Brazil to compensate for the devaluation, and experience a 20% drop in volume. Direct costs in the U.S. are 60% of the U.S. sales price. What would be the short-run (1 year) implication of each pricing strategy? Which do you reccomend?
Explanation / Answer
Answer:
Exchange rate Prices in Assumptions US dollar prices (R$/$) Brazilian reais Existing sales price per unit $200.00 3.4000 680 If the reais falls in value, the new implied US$ price: New dollar price if no reais price change $170.00 4.0000 680 If the US$ price is changed to keep US$ price: New reais price is current US$ price at new exchange rate: $200.00 4.0000 800 Direct cost per unit in the US, percent of price 60% Direct cost per unit in the US $120.00 3.4000 408 Unit volume 50,000 Decrease in unit volume from price increase -20.0% New lower unit volume 40,000 Alternative #1: Maintain same price in reais: Sales revenue (R$680 x 50,000 ) / (R$4.000/$) $8,500,000 Less direct costs (US$120 x 50,000) 6,000,000 Contribution margin in US dollars $2,500,000 Alternative #2: Raise price in reais (and accept lower volume): Sales revenue (R$800 x 40,000 ) / (R$4.000/$) $8,000,000 Less direct costs (US$120 x 40,000) 4,800,000 Contribution margin in US dollars $3,200,000 Discussion Alternative #2 is preferable. In the short run (one year), DZ would be better off to increase its sales price in reais in Brazil and accept the lower sales volume. The contribution margin if reais prices are raised is $3,200,000, whereas if the price in reais is left unchanged DZ's contribution margin is only $2,500,000. This is a short-run solution, and does not consider possible longer-run effects that might come from raising the local price and/or accepting a smaller market share.Related Questions
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