For over 100 years Progress Lighting, a U.S.-based company, has been committed to providing a diverse selection of high quality lighting fixtures earning it the reputation as the #1 decorative lighting line. The companys costs and revenues have been very stable over time. Its profits have been adequate but Progress Lighting has been searching for means of increasing profits in the future. The U.S. dollar is the official currency of the United States. It has recently been negotiating with a Mexican firm called Coron Company, from which it will purchase some necessary parts.

Every 3 months, Coron Company will send a specified number of parts with the bill invoiced in Mexican pesos. By having the parts produced by Coron, Progress Lighting expects to save about 20 percent on production costs. Coron is willing to work out a deal only if it is assured that it will receive a minimum specified amount of orders every 3 months over the next 10 years, for a minimum specified amount.

The price of the parts will change over time in response to the costs of production. Progress Lighting recognizes that the cost to Coron will increase substantially over time as a result of the very high inflation rate in Mexico. Therefore, the price charged in Mexican pesos likely will rise substantially every 3 months. However, Progress Lighting feels that, because of the concept of purchasing power parity (PPP), its U.S. dollar payments to Coron will be stable. According to PPP, if Mexican inflation is much higher than U.S. inflation, the Mexican peso will weaken against the U.S. dollar by that difference. Since Progress Lighting does not have much liquidity, it could experience a severe cash shortage if its expenses are much higher than anticipated.

The demand for Progress Lightings product has been stable and is expected to continue that way. Since the U.S. inflation rate is expected to be very low, Progress Lighting likely will continue pricing its lamps at todays prices (in U.S. dollars). It believes that by saving 20 percent on production costs it will

substantially increase its profits. It is about ready to sign a contract with Coron Company.

1. Describe a scenario that would cause Progress Lighting to save even more than 20 percent on production costs.

2. Describe a scenario that would cause Progress Lighting to actually incur higher production costs than if it simply had the parts produced in the United States.

Note: Your answers should be based on the concept of purchasing power parity (PPP).