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For this topic, I want you to look at risk sharing agreements, in particular what might happen to a firm's gross profits based on pricing decisions following a change in exchange rates.

American Plumbing Products, based in New Jersey, imports copper from Peru Copper Co., a reliable and long time supplier based in Lima, Peru. Payment is in Peru sol (symbol is "S/"), with a current exchange rate of S/4.00/$; American Plumbing is concerned that changes in the exchange rate could have cause its costs to rise. Given that trading partners want to continue their longtime relationship, they agree on a risk sharing arrangement. As long as the spot rate on the date of an invoice is between S/3.50/$ and S/4.50/$, American Plumbing will pay in Peru sol based on the spot rate. If the exchange rate falls outside this range, American Plumbing will still pay in Peru sol, but will share the difference in the spot rate equally with Peru Copper. The risk-sharing agreement will last for six months, at which time the exchange rate limits will be reevaluated.

American Plumbing enters into a contract to buy copper products from Peru Copper for S/8,000,000 during the next six months. If the exchange rate stayed at S/4.00/$ that would equate to $2,000,000.

Assume the exchange rate is S/3.00/$ (dollar now buys less sol than it did at time of contract) and American Plumbing owes Ps8,000,000 to Peru Copper.

4. How much would American Plumbing owe to Peru Copper in U.S. dollars without the risk sharing agreement?

5. How much would American Plumbing owe to Peru Copper in U.S. dollars with the risk sharing agreement?

6. In this scenario, does American Plumbing pay more or less with the risk sharing agreement?

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