Foreign Exchange Impacts On Transaction Profitability

Overviewforeign Exchange Impacts The Profitability Of Transactions In

Overview foreign exchange impacts the profitability of transactions in international markets. It can turn a profitable business into one that loses money and can turn an unprofitable business into one that makes money. In this assignment, you will analyze the impact of foreign exchange on different business scenarios and present your findings in a short business memo. 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, create 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.

Paper For Above instruction

The profitability of international transactions for manufacturing companies hinges significantly on foreign exchange rates, which can fluctuate unpredictably, affecting revenue and cost structures. This paper analyzes three scenarios based on the provided data, underlining the critical importance of managing foreign exchange risks to preserve profitability.

In Scenario 1, the company uses the spot rate on April 1st (3.52 MYR per USD) to convert its sales revenue from MYR to USD. The total sales amount is 1.25 million MYR, which, when divided by the spot rate, results in approximately $355,113 USD (1,250,000 MYR / 3.52 MYR/USD). Given the break-even point of $90 per unit across 4,000 units, total revenue should be at least $360,000 to avoid losses. Therefore, with the spot rate at the time of sale, the revenue slightly falls below the break-even threshold, indicating a potential loss if the exchange rate remains unfavorable or further depreciates. This underscores the risks of relying solely on spot rates without hedging strategies.

Scenario 2 involves the company locking in a forward rate of 0.317 USD/MYR on January 1st, effectively fixing the amount of USD received regardless of fluctuations by April 1st. The transaction value at this rate would be approximately $397,500 (1,250,000 MYR * 0.317 USD/MYR), exceeding the break-even revenue comfortably. This forward contract reduces exchange rate risk, ensuring profitability if the spot rate worsens or remains volatile. Hedging through a forward contract thus demonstrates a proven method to stabilize revenue streams and mitigate potential losses from unfavorable rate movements.

Scenario 3 considers avoiding currency exchange by purchasing raw materials directly in MYR, thereby eliminating foreign exchange risk altogether. By executing transactions in the local currency, the company can control costs and avoid the uncertainty associated with exchange rate fluctuation. However, this approach requires local suppliers willing to sell raw materials in MYR and may involve logistical or legal challenges. It may also limit flexibility if global suppliers or broader supply chain considerations favor USD or other currencies.

In determining whether to buy raw materials in MYR, the company must weigh factors such as currency stability, supplier relationships, transaction costs, and future exchange rate trends. Hedging strategies like forward contracts or options are often more flexible and less disruptive than local procurement but involve additional costs and complexities. Prioritizing currency risk management aligns with maintaining stable profit margins and avoiding unanticipated losses.

In conclusion, entire international operations should integrate foreign exchange risk assessments into their financial planning. The two scenarios reveal that locking in rates through forward contracts can secure profitability, especially in volatile markets, while reliance on spot rates exposes businesses to adverse rate fluctuations. Directly purchasing in local currencies offers another route to mitigate risks but requires careful evaluation of supply chain logistics and local market conditions. Overall, proactive foreign exchange management is vital for safeguarding company profitability, enabling firms to navigate currency fluctuations confidently, and maintain sustainable international operations.

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