Scenario

You manage the international business for a manufacturing company. You are responsible for the overall profitability of your business unit. Your company ships your products to Malaysia. The retail stores that buy your products there pay you in their local currency, the Malaysian ringgit (MYR). All sales for the first quarter are paid on April 1st and use the exchange rate at the close of business on April 1st or the first business day after April 1st if it falls on a Saturday or Sunday. The company has sales contracts with different vendors that determine the number of units sold well in advance. The company is contractually obligated to sell 4,000 units for exactly 1.25 million MYR for the first quarter. The break-even point for each unit is $90 in U.S. dollars. Use the following foreign exchange rates:

• On January 1, the daily spot rate is 3.13 MYR, and the forward rate is 0.317 U.S. dollars/MYR for April 1st of the same year.
• On April 1, the daily spot rate is 3.52 MYR.

Prompt

Using the information above, explain a short business memo that explains the profitability, viability, and importance of considering foreign exchange on the basis of the scenarios below.

Scenario 1: The company uses the spot rate on April 1st to convert its sales revenue in MYR to U.S. dollars.

Scenario 2: On January 1st, the company uses that day’s forward rate today to lock in a foreign exchange rate for its expected 1.25 million MYR in sales. This means the company agreed to exchange 1.25 million MYR using the forward rate on January 1st when April 1 arrives.

Scenario 3: Another option for the company is to spend the foreign currency and avoid any currency exchange. Because it is a manufacturing company, raw materials are always needed.

Specifically, you must address the following rubric criteria:

• Foreign Exchange Calculations: Determine the profitability of the international business by using foreign exchange calculations for the first and second scenarios.
• Spend or Save: Discuss what you would need to consider when determining if the company should buy raw materials with the foreign currency in an effort to avoid foreign exchange risk and whether this is a viable option for the company.
• Conclusion: After determining the result for each scenario, explain the importance to a company’s financial results of considering foreign exchange risk.

All in a Business memo in a word Microsoft Word document.

ANSWER

[Your Name]
[Your Title/Position]
[Date]

Subject: Considerations on Foreign Exchange and its Impact on Profitability

Dear [Recipient’s Name],

I hope this memo finds you well. As the manager of international business for our manufacturing company, I would like to bring to your attention the importance of considering foreign exchange risk and its potential impact on our profitability. In light of our sales contracts with vendors in Malaysia, who pay us in Malaysian ringgit (MYR), it is crucial that we analyze three different scenarios to determine the most favorable approach for our business.

Scenario 1: Spot Rate Conversion on April 1st

If we choose to convert our MYR sales revenue to U.S. dollars using the spot rate on April 1st, we would face uncertainty in the exchange rate. As of January 1st, the daily spot rate was 3.13 MYR, but by April 1st, it increased to 3.52 MYR. Let’s calculate the profitability based on the given information:

Total MYR Sales Revenue = 1,250,000 MYR
Total U.S. Dollars Revenue (using spot rate on April 1st) = 1,250,000 MYR / 3.52 MYR/USD = $355,113.64 USD

Total Cost of Units Sold = 4,000 units * $90 USD = $360,000 USD

Profit/Loss = Total U.S. Dollars Revenue – Total Cost of Units Sold
Profit/Loss = $355,113.64 USD – $360,000 USD = -$4,886.36 USD

In this scenario, we would incur a loss of approximately $4,886.36 USD due to the unfavorable exchange rate, impacting the overall profitability of our international business.

Scenario 2: Forward Rate Lock-in on January 1st

Alternatively, we could have opted to lock in a foreign exchange rate for our expected 1.25 million MYR in sales on January 1st, using the forward rate of 0.317 USD/MYR for April 1st. Let’s calculate the profitability based on this approach:

Total U.S. Dollars Revenue (using forward rate on January 1st) = 1,250,000 MYR * 0.317 USD/MYR = $396,250 USD

Profit/Loss = Total U.S. Dollars Revenue – Total Cost of Units Sold
Profit/Loss = $396,250 USD – $360,000 USD = $36,250 USD

By utilizing the forward rate, we would have generated a profit of $36,250 USD. This highlights the significance of locking in a favorable exchange rate to mitigate foreign exchange risk and ensure better financial results.

Scenario 3: Utilizing Foreign Currency for Raw Material Purchases

Considering our continuous need for raw materials as a manufacturing company, we have the option to spend the foreign currency (MYR) on purchasing these materials directly. By doing so, we can avoid the risk associated with currency exchange fluctuations. However, before deciding on this approach, we must consider a few factors:

a) Supplier Pricing: We need to assess if purchasing raw materials in MYR directly from suppliers is economically viable and whether it offers cost advantages compared to sourcing them internationally.

b) Currency Stability: The stability of the MYR against other currencies is critical. If the MYR is subject to high volatility, it might be more prudent to consider foreign exchange risk management strategies instead.

c) Cash Flow Management: We must ensure that we have sufficient MYR funds to cover raw material expenses without impacting other essential operations.

Conclusion:

In conclusion, analyzing the impact of foreign exchange on our international business is imperative for ensuring profitability and financial stability. Scenario 1, which involves using the spot rate on April 1st for currency conversion, exposes us to potential losses due to fluctuating exchange rates. On the other hand, Scenario 2 demonstrates the benefits of locking in a forward rate early on to secure favorable exchange rates and maximize profits.

Regarding Scenario 3, while utilizing foreign currency for raw material purchases might help mitigate exchange risk, it requires careful evaluation of various factors to determine its viability. As an international business, understanding and managing foreign exchange risk play a pivotal role in optimizing our financial performance and safeguarding the overall profitability of our company.

Please feel free to reach out if you require further analysis or clarification on any of the scenarios discussed.

Thank you for your attention.

Sincerely,

[Your Name]
[Your Title/Position]