Mark Sexton and Todd Story, the owners of S&S Air, have been in discussions with

Question

Mark Sexton and Todd Story, the owners of S&S Air, have been in discussions with a light aircraft dealer in Monaco about selling the company's planes in Europe. Jarek Jachowicz, the dealer, wants to add S&S Air to his current retail line. Jarek has told Mark and Todd that he feels the retail sales will be approximately 5 million per month. All sales will be made in euros, and Jarek will retain 5 percent of retail sales as a commission, which will be paid in euros. Because the planes will be customized to order, the first sales will take place in one month. Jarek will pay S&S Air for the order 90 days after it is filled. This payment schedule will continue for the length of the contract between the two companies. Mark and Todd are confident the company can handle the extra volume with its existing facilities, but they are unsure about the potential financial risks of selling their planes in Europe. In their discussion with Jarek, they found that the current exchange rate is $1.35/. At the current exchange rate, the company would spend 80 percent of the sales on production costs. This number does not reflect the sales commission paid to Jarek. Mark and Todd have decided to ask Chris Guthrie, the company's financial analyst, to prepare an analysis of the proposed international sales. Specifically, they ask Chris to answer the following questions. QUESTIONS What are the pros and cons of the international sales? What additional risks will the company face? What happens to the company's profits if the dollar strengthens? What if the dollar weakens? Ignoring taxes, what are S&S Air's projected gains or losses from this proposed arrangement at the current exchange rate of $1.35/? What happens to profits if the exchange rate changes to $1.25/? At what exchange rate will the company break even?

Explanation / Answer

Sales in Euros= 5 million Sales commission=5% of retail sales Current exchange rate= 1euro=$1.35 At current exchange rate- production costs=80% of sales excluding commission S&S profit or loss with proposed arrangement at current exchange rate of 1.35$: Sales= 5000000*1.35=6750000 sales commission@5%= 337500 Net sales= 6412500 production costs@80% of sales= 6750000*80%=5400000 Profit= 1012500 Pros and cons of international sales: Pros: Increase in sales base and expension of the entity Greater reach of companys products and services Increased brand value Global recognition Cons: Exchange rate fluctuations lead to Forex risks increased compliances with international laws Lack of instant recovery of dues If dollar strengthens against Euros: Company receives sale proceeds in Euros whose value falls with respect to $ Hence company incurs forex loss So company profit falls down If dollar weakens against Euro: Company receives Euros whose value is strong comapared to $ Hence company profits increases due to Exchange gain If exchage rate is 1 Euro=1.25$ : sales = 5000000*1.25=6250000 Sales commission @5%= 312500 Net sales= 5937500 Production cost =5400000 Profit: 537500 Note: production cost doesn’t change with change in exchange rate Hence it remains same as above i.e 5400000 Break even sales is sales at which company has no profit or loss: let sales = x Commision on sales= 5%x Net sales=95 %x costs=5400000 Profit=0 95% x -5400000=0 95% x= 5400000 x= 5684210 break even sales = 5684210

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