Read the following case and respond to the questions. However, before you read the case, read the few sentences immediately below on the impact of currency fluctuations on a company's revenues.
Currency fluctuations can wipe out profits for an international company. For example, If a Germany company plan to sell a machine for $300,000 to a U.S. company at a time when the exchange rate is 1 euro to 1.33 dollars, then it expects to get 225,564 euros in revenue ($300,000 / 1.33 = 225,564 euros).
If the exchange rate changes to 1 euro to 1.50 dollars, than the German company will get only 200,000 euros ($300,000 /1.50 = 200,000 euros). Over 25,000 euros in expected profits has been wiped out by currency fluctuations. If the machine cost 205,000 euros to make, the German company would be selling it at a loss if it only received 200,000 euros.
Now that you see how currency fluctuations can affect profits, please read the following case and respond to the questions.
Udo Pfeiffer, the CEO of SMS Elotherm, a German manufacturer of machine tools to engineer crankshafts for cars, signed a deal in late November 2004, to supply the U.S. operations of DaimlerChrysler with $1.5 million worth of machines. The machines would be manufactured in Germany and exported to the United States. When the deal was signed, Pfeiffer calculated that at the agreed price, the machines would yield a profit of 30,000 euros each. Within three days that profit had declined by 8,000 euros! The dollar had slid precipitously against the euro. SMS would be paid in dollars by DaimlerChrysler, but when translated back into euros, the price had declined. Since the company's costs were in euros, the declining revenues when expressed in euros were squeezing profit margins.
With the exchange rate standing at 1 euro equal to $1.33 in early December 2004, Mr. Pfeiffer was deeply worried. He knew that if the dollar declined further to around 1 euro to $1.50, SMS would be losing money on its sales to American. He could try to raise the dollar price of his products to compensate for the fall in the value of the dollar but he knew that was unlikely to work. The market for machine tools was very competitive and manufacturers were constantly pressuring machine tool companies to lower prices not raise them.
Another small German supplier to U.S automobile companies, Keiper, was faring somewhat better. In 2001 Keiper, which manufactures metal frames for automobile seats, opened a plant in London, Ontario, to supply the U.S operations of DaimlerChrysler. At the time the investment was made, the exchange rate was 1 euro equaled 1 dollar. Management at Keiper had agonized over whether the investment made sense. Some in the company felt that it was better to continue exporting from Germany. Others argued that Keiper would benefit from being close to a major customer. Now with the euro appreciating every day, it looked like a smart move. Keiper had a real hedge against the rising value of the euro. But the advantages of being based in Canada were tempered by two things; first, the U.S. dollar had also depreciated against the Canadian dollar, although not by as much as its depreciation against the euro. Second, Keiper was still importing parts from Germany, and the euro had also appreciated against the Canadian dollar, raising the cost of Keiper's Ontario plant.
Case Discussion Question
Could SMS Eloherm have taken steps to avoid the position it now found itself it? What were those steps? Why do you think the company did not take those steps? If the U.S. dollar had appreciated against the euro and Canadian dollar, instead of depreciating, which company would have done better? Why?
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SMS Eloherm could have taken steps to avoid the position it now finds itself in. Before signing a contract locking the company into being paid in dollars, the company could have insisted that the product be paid for in Euros. By requiring DaimlerChrysler to pay in SMS Eloherm's own currency (the euro) SMS Eloherm is not impacted by currency fluctuations. Of course, should the dollar rise against the ...
This detailed solution discusses the impact of currency fluctuations on a company's finances. It deals with a case study involving SMS Eloherm and DaimlerChrysler and offers suggestions for tempering the impact of currency fluctuations in foreign trade. Includes APA formatted references.