Flame Fixtures, Inc. Case Study
Business Application of Purchasing Power Parity
Flame Fixtures, Inc., is a small U.S. business in Arizona that produces and sells lamp fixtures. Its costs and revenues have been very stable over time. Its profits have been adequate, but Flame has been searching for a means of increasing profits in the future.
It has recently been negotiating with a Mexican firm called Corón Company, from which it will purchase some of the necessary parts. Every three months, Corón Company will send a specified number of parts with the bill invoiced in Mexican pesos. By having the parts produced by Corón, Flame expects to save about 20 percent on production costs. Corón is only willing to work out a deal if it is assured that it will receive a minimum specified amount of orders every three months over the next 10 years, for a minimum specified amount. Flame will be required to use its assets to serve as collateral in case it does not fulfill its obligation. The price of the parts will change over time in response to the costs of production. Flame recognizes that the cost to Corón will increase substantially over time as a result of the very high inflation rate in Mexico. Therefore, the price charged in pesos likely will rise substantially every three months. However, Flame feels that, because of the concept of purchasing power parity (PPP), its dollar payments to Corón will be very stable.
According to PPP, if Mexican inflation is much higher than U.S. inflation, the peso will weaken against the dollar by that difference. Since Flame does not have much liquidity, it could experience a severe cash shortage if its expenses are much higher than anticipated. The demand for Flame’s product has been very stable and is expected to continue that way. Since the U.S. inflation rate is expected to be very low, Flame likely will continue pricing its lamps at today’s prices (in 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 Corón Company.
Guidelines for Case Study: For this assignment, you are to evaluate the mini case study. The central issue in your analysis should be to describe what the case tells us about the theory and practice of International Finance Management. In analyzing the case, you should draw upon class readings, internet resources as well as personal experiences that may be relevant. Some general questions that you may want to consider include the following:
What are the issues?
Who are the actors?
What are the organizational forces?
What are the external forces?
What theoretical perspectives or models help you understand what happened in the case? How?
What does the case tell us about: The environment within which International Finance occurs? The nature of the International Finance Management system and the policy making process? The decision making process? Leadership and management? Administrative ethics?
What recommendations would I make?
How would I propose to do things differently?