A European car manufacturer expects to sell 30,000 cars in the United States. The sale price of

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Question:

A European car manufacturer expects to sell 30,000 cars in the United States. The sale price of each vehicle is 90,000 USD, while the total cost of producing each vehicle is 60,000 EUR. The cost and sale price of each vehicle is certain. Currently, 0.90 EUR can be exchanged for 1.00 USD.

(a) Compute the manufacturer's total expected profit (in EUR) from the sale of 30,000 cars in the United States, at the current exchange rate of 0.90 EUR to 1.00 USD.

(b) Compute the manufacturer's total expected profit (in EUR) from the sale of 30,000 cars in the United States, if the exchange rate were to fall from 0.90 EUR to 0.85 EUR per 1.00 USD.

(c) Would the fall in the exchange rate represent an appreciation or a depreciation of EUR relative to USD? State "appreciation" or "depreciation". No explanation is required.

(d) Compute the percentage change in total expected profit (in EUR) brought about by a fall in the exchange rate from 0.90 EUR to 0.85 EUR per 1.00 USD.

The European car manufacturer would like to eliminate some exchange rate risk. To reduce risk, the manufacturer is considering producing in the United States all cars that it sells in the United States. It would cost 10,000,000 EUR to establish manufacturing facilities in the United States. The cost of producing each vehicle in the United States would be 66,666.67 USD.

(e) Compute the manufacturer's total expected profit (in EUR) from the production and sale of 30,000 cars in the United States, at the current exchange rate of 0.90 EUR per 1.00 USD. In your calculation, ignore the cost of establishing the manufacturing facilities in the United States.

(f) Compute the manufacturer's total expected profit (in EUR) from the sale of 30,000 cars in the United States, if production were shifted to the United States and if the exchange rate were to fall from 0.90 EUR to 0.85 EUR per 1.00 USD. In your calculation, ignore the cost of establishing the manufacturing facilities in the United States.

(g) Compute the percentage change in total expected profit (in EUR) brought about by a fall in the exchange rate from 0.90 EUR to 0.85 EUR per 1.00 USD, if production were shifted to the United States. In your calculation, ignore the cost of establishing the manufacturing facilities in the United States.

(h) Is the percentage change in total expected profit (in EUR) in response to the fall in the exchange rate larger or smaller if production is shifted to the United States than if production remained in Europe? State "larger" or "smaller", and interpret your result in one sentence. Again ignore the cost of establishing the manufacturing facilities in the United States.

The European car manufacturer is considering an alternative risk management strategy involving put options. The manufacturer can buy at-the-money put options for the right to exchange USD for EUR at the current exchange rate of 0.90 EUR to 1.00 USD. Each put option contract gives the manufacturer the right to sell 1,000,000 USD for 900,000 EUR, and each put option contract costs the manufacturer 3,700 EUR.

(i) Compute the number of put option contracts the manufacturer should purchase, if the manufacturer wants to eliminate as much exchange rate risk as possible, based on the expected sales volume of 30,000 cars.

(j) Compute the manufacturer's total expected profit (in EUR) from the sale of 30,000 cars in the United States, if the manufacturer purchases the number of put option contracts that you calculated in part (i), and if the exchange rate were to fall from 0.90 EUR to 0.85 EUR per 1.00 USD. In your calculation, ignore the cost of the put option contracts.

(k) Based on your results so far, after accounting for the explicit costs of shifting production to the United States or buying put options, would you recommend that the manufacturer shift production or buy puts? State "shift production" or "buy puts", and explain your answer in one sentence.