Question

Hurte-Paroxysm Products, Inc. (HP) of the United States exports computer printers to Brazil, whose currency, the reals (symbol R$) havebeen trading at R$3.40/US$. Exports to Brazil are currently 50,000 printers per year at the reals equivalent of $200 each. A strong rumor exists that the reals will be devalued to R$4.00/$ within two weeks by the Brazilian government. Should the devaluation take place, the exchange rate isexpected to remain unchanged for the foreseeable future. Based on this forecast, HP Products may either (1) maintain the same realprice and sell for fewer dollars, in which case Brazilian volume will not change, or (2) maintain the same dollar price, raise the realprice 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.

Required:
a. What would be the short-run (one-year) impact of each pricing strategy?
b. Which do you recommend?

If HP maintains the same real price and same unit volume, what will be the firm's gross profits?

Answer 1

Answer:

Hurte-Paroxysm Products, Inc. (HP)

The short-run impact of each pricing strategy is as follows:

                                           Alternative 1                      Alternative 2

                             Reduce Price to $170     Maintain Price of $200

Gross profit                        $2,500,000               $3,200,000

Reduction in Gross Profit   $1,500,000                  $800,000

b. (2) maintain the same dollar price of $200, raise the real price in Brazil (to R$800 from R$680)to compensate for the devaluation, and experience a 20% drop in volume.

c. If HP maintains the same real price and same unit volume, the firm's gross profits will be $2,500,000.

Explanation:

a) Data and Calculations:

Exchange rate = R$3.40/US$

Current exports of printers per year to Brazil = 50,000

US unit price of printer in dollars = $200

Brazil unit price of printer in R$ equivalent = R$680 ($200 * R$3.40)

Unit price of printer in R$ when reals is devalued = R$800 ($200 * R$4.00)

The reduced dollar price with devaluation, when real price is maintained = $170 (R$680/R$4.00)

Before Devaluation of Brazil's Real (R$):

Sales volume            50,000

Sales revenue $10,000,000 (50,000 * $200)

Direct costs         6,000,000 (50,000 * $120)

Gross profit       $4,000,000

                              Alternative 1                  Alternative 2

                       Reduce Price to $170     Maintain Price at $200

Sales volume                50,000                      40,000 (50,000 * 80%)

Sales revenue      $8,500,000               $8,000,000 ($200 * 40,000)

Direct costs            6,000,000                  4,800,000 ($120 * 40,000)

Gross profit         $2,500,000                $3,200,000 ($80 * 40,000)

Direct costs = $6m ($120 * 50,000)        = $4.8m ($120 * 40,000)