Mucho Macho is the leading beer in Patagonia, with a 65% share of the market. Because of trade barriers, it faces essentially no import competition. Exports account for less than 2% of sales. Although some of its raw material is bought overseas, the large majority of the value added is provided by locally supplied goods and services.
Over the past five years, Patagonian prices have risen by 300%, and U.S. prices have risen by about 10%. During this time period, the value of the Patagonian peso has dropped from P1 = $1.00 to P 1 = $0.50.
a. What has happened to the real value of the peso over the past five years? Has it gone up or down? A little or a lot?
b. What has the high inflation over the past five years likely done to Mucho Macho's peso profits? Has it moved profits up or down? A lot or a little? Explain.
c. Based on your answer to Part a, what has been the likely effect of the change in the peso's real value on Mucho Macho's peso profits converted into dollars? Have dollar-equivalent profits gone up or down? A lot or a little? Explain.
d. Mucho Macho has applied for a dollar loan to finance its expansion. Were you to look solely at its past financial statements in judging its creditworthiness, what would be your likely response to Mucho Macho's dollar loan request?
e. What foreign exchange risk would such a dollar loan face? Explain.