Question

The Atlas Corp. of the United States exports computer software to the euro zone. Sales are currently 5,000,000 units per year at the euro equivalent of $126 each. The current exchange rate is $1.1280/€ but the dollar is expected to appreciate next week by 8.64% after which it will remain unchanged for at least ten years. Accepting this forecast, Atlas Corp. faces a pricing decision in anticipation of the appreciation. It may either 1) maintain the same euro price and in effect sell for fewer dollars, in which case its export volume will increase by 8% per year for the first five years and then by 5% per year for the following five years, or 2) maintain the same dollar price, raise the euro price in Europe to compensate for the depreciation, and experience a 20% drop in volume during the current year, followed by an increase of 3% per year for the following nine years. Dollar costs will not change. At the end of ten years, the software will be obsolete and will no longer be exported. After the dollar appreciates by 8.64% no further appreciation is expected. Direct costs are currently 70% of the U.S. sales price and that cost will not change over the ten year horizon. Atlas’ weighted average cost of capital is 15%. Given these considerations, which pricing policy should Atlas follow? Explain your decision and comment on the implications of the result from the point of view of competitive exposure.

Answer 1

	$/Euro
current exchange rate	1.128
next week	1.0305408
Current Sales units	5000000
Current Price	126	$	or	111.7021277	Euro
Sales value	630000000	$
Option 1
Price (after depriciation)	111.70213	Euro	or	115.1136	$
Volume increase for first 5 years	8%
Volume increase for next 5 years	5%
Years	Sales ($)	Cost ($)	Profit ($)	Present value
1	621613440	435129408	186484032	162160028
2	621613440	435129408	186484032	141008720
3	621613440	435129408	186484032	122616278
4	621613440	435129408	186484032	106622851
5	621613440	435129408	186484032	92715522
6	604346400	423042480	181303920	78382688
7	604346400	423042480	181303920	68158859
8	604346400	423042480	181303920	59268573
9	604346400	423042480	181303920	51537890
10	604346400	423042480	181303920	44815556
NPV	927286964
Option 2
Price (after depriciation)	126	$	or	122.2659016	Euro
Volume decrease for first year	-20%
Volume increase for next 9 years	3%
Years	Sales ($)	Cost ($)	Profit ($)	Present value
1	504000000	352800000	151200000	131478261
2	504000000	352800000	151200000	114328922
3	504000000	352800000	151200000	99416454
4	504000000	352800000	151200000	86449091
5	504000000	352800000	151200000	75173122
6	648900000	454230000	194670000	84161213
7	648900000	454230000	194670000	73183664
8	648900000	454230000	194670000	63637968
9	648900000	454230000	194670000	55337364
10	648900000	454230000	194670000	48119447
NPV	831285506

Since, NPV from option 1 is higher, it should be preferred over option 2