Case Study Four|
S&S Air International?|
The business world is highly competitive, changes quickly and is filled with risks and rewards. The international business world is no different! Things can change on the international stage in the time it takes to get a cup of tea! S&S Air has been in discussions with a dealer in Europe to sell the company’s model known as “The Eagle”. The dealer, Amalie Diefenbaker, has told S&S Air that she will pay the company €60,000 (€, Euro) per plane. She will order 15 planes a month and will pay for all 15 planes within 90 days; the intention would be to continue to order 15 planes each month. S&S Air is confident that they can meet the increase in demand with their current facilities but are unsure of the risks involved with taking their product to the international stage. This paper will analyze the pros and cons, as well as additional risks S&S Air will face. We will discuss some options for S&S Air to hedge the exchange rate risk and make a recommendation on bringing “The Eagle” to Europe. Some pros to bringing “The Eagle” to Europe are obvious and will need little explanation such as gaining access to a new market. By entering this new market S&S Air has the potential to increase sales and profits either through volume, exchange rate, or both! By entering this new market and introducing their product to new customers, and possibly investors, S&S Air may experience a much faster growth rate. While there will be increased competition because S&S Air is the new player in the market this could be a good thing. The exposure to foreign competition can lead to an increase in quality as well as efficiency. All these things are fairly obvious and to go into detail in this paper would distract us from analyzing our main objective, exchange rate(s) and the risks associated with them. S&S Air will see its profits increase or decrease depending on how the exchange rate is quoted. Generally they are quoted as units of a particular country’s currency per dollar. In this case the specific unit of measure is the Euro (€). Based on this assumption we know that S&S Air Inc.’s profits will rise as the dollar strengthens (appreciates) and fall as the dollar weakens (depreciates). Furthermore Relative Purchasing Power Parity tells us that the exchange rate will rise if the U.S. inflation rate is lower than the foreign country’s (Ross, Westerfield, Jordan Essentials of Corporate Finance Seventh Edition, P.576). This means that if the inflation rate of the U.S. is lower than that of (in this case) the European Union than the dollar is more valuable than the Euro, put another way it will take more Euro(s) to buy one dollar. As mentioned above S&S Air has the potential to increase sales and profits. One way they can do that is through exchange rates by entering into a forward trade with Amalie. A forward trade means that S&S Air and Amalie will agree to exchange money, at a pre-determined exchange rate, in the future; in this case we will assume within 90 days. S&S Air currently sells The Eagle for USD $78,000, and has variable costs of USD $60,000. The variable costs are costs that must be covered. The current exchange rate is USD $1.30/€. S&S Air will sell The Eagle to Amalie for €60,000, which at this exchange rate equals USD $78,000 ($1.30 x 60,000 = $78,000). As we’ve shown at USD $1.30/€ S&S Air sees no gains or losses from entering into this agreement, this exchange rate gives them USD $78,000 which is exactly what they would get if they continued to sell The Eagle exclusively in the U.S.. The variable costs of the Eagle are USD $60,000 and these costs, as stated above, must be covered. Knowing that we know that the breakeven exchange rate must be USD $1.00 = €1.00 at a sales price to Amalie of €60,000. If the exchange rates changes to USD $1.37/€ then...