Comparative Advantage: Toys Wine Assumptions (Containers/unit) (Cases/unit)

Comparative Advantage
Problems 1-5 illustrate an example of trade induced by comparative advantage. They assume that China and France
each have 1,000 production units. With one unit of production (a mix of land, labor, capital, and technology), China
can produce either 10 containers of toys or 7 cases of wine. France can produce either 2 cases of toys or 7 cases of
wine. Thus, a production unit in China is five times as efficient compared to France when producing toys, but
equally efficient when producing wine. Assume at first that no trade takes place. China allocates 800 production
units to building toys and 200 production units to producing wine. France allocates 200 production units to building
toys and 800 production units to producing wine.
Problem 1.1 Production and Consumption

What is the production and consumption of China and France without trade?
Toys
(containers/unit)
10
2
1,000
1,000
Wine
(cases/unit)
7
7
Toys
Wine
CHINA
Allocated production units to
Produces and consumes (output per unit x units allocated)
800
8,000
200
1,400
FRANCE
200
400
800
5,600
8,400
7,000
Assumptions
China -- output per unit of production input
France -- output per unit of production input
China -- total production inputs
France -- total production inputs
Production if there is no trade
Total production and consumption across both countries
Problem 1.2 Specialization

Assume complete specialization, where China produces only toys and France produces only wine. What would be
the effect on total production?
Assumptions
Production if there is complete specialization

CHINA
FRANCE
Toys
(containers/unit)
10
2
1,000
1,000
Wine
(cases/unit)
7
7
Toys
Wine
1,000
10,000
10,000
The combined production of both countries is 10,000 containers of toys, 1,600 more containers of toys than
before specialization, with wine production remaining unchanged.
1,000
7,000
7,000
Problem 1.3 Trade at China's Domestic Price

Chinas domestic price is 10 containers of toys equals 7 cases of wine. Assume China produces 10,000 containers of toys and exports 2,000 to France. Assume France produces
7,000 cases of wine and exports 1,400 cases to China. What happens to total production and consumption?
Assumptions
Trade at China's domestic price (10 toys = 7 wine)

CHINA
FRANCE
Toys
(containers/unit)
10
2
1,000
1,000
Wine
(cases/unit)
7
7
Toy
Production
TOYS
Exports (-)/
Imports (+)
Domestic
Consumption
1,000
10,000
(2,000)
8,000
2,000
2,000
1,000
7,000
10,000
7,000
10,000
Wine
Production
WINE
Exports (-)/
Imports (+)
Domestic
Consumption
1,400
1,400
(1,400)
5,600
7,000
With complete specialization, toy production in total is increased as in Problem 2.

Toy production and consumption in France increases from 400 containers of toys before trade to 2000 containers after trade, a gain in consumption of 1600 containers.
Wine production and consumption remains the same as before trade. China is now consuming 8,000 containers of toys and 1,400 cases of wine, the same levels of both as prior to trade. Hence all of
the benefits of trade have gone to France.
Problem 1.4 Trade at France's Domestic Price

Frances domestic price is 2 containers of toys equals 7 cases of wine. Assume China produces 10,000 containers of toys and exports 400 containers to France. Assume France in
turn produces 7,000 cases of wine and exports 1,400 cases to China. What happens to total production and consumption?
Assumptions
Trade at France's domestic price (2 toys = 7 wine)

CHINA
FRANCE
Toys
(containers/unit)
10
2
1,000
1,000
Wine
(cases/unit)
7
7
Toy
Production
TOYS
Exports (-)/
Imports (+)
Domestic
Consumption
1,000
10,000
(400)
9,600
400
400
1,000
7,000
10,000
7,000
10,000
Wine
Production
WINE
Exports (-)/
Imports (+)
Domestic
Consumption
1,400
1,400
(1,400)
5,600
7,000
Toy production and consumption in China increases from 8,000 containers of toys before trade to 9,600 containers -- 1,600 more containers -- after trade. Wine production and consumption remains
the same as before trade. Thus the full benefit of trade goes to China when trading at France's domestic prices.
Problem 1.5 Trade at Negotiated Mid-Price

The mid-price for exchange between France and China can be calculated as follows:
Assumptions
Toys
(containers/unit)
10
2
1,000
1,000
Wine
(cases/unit)
7
7
What happens to total production and consumption?
Trade at Negotiated Mid-Price (6 toys = 7 wine)

CHINA
FRANCE
Toy
Production
TOYS
Exports (-)/
Imports (+)
Domestic
Consumption
1,000
10,000
(1,200)
8,800
1,200
1,200
1,000
7,000
10,000
7,000
10,000
Wine
Production
China gains 800 more containers of toys (8,800 post-trade compared to 8,000 pre-trade), and enjoys the same level of wine consumption (1,400).
France gains 800 more containers of toys (1,200 post-trade compared to 400 pre-trade), and enjoys the same level of wine consumption (5,600).
Wine production therefore remains the same as before trade, but now the 1,600 increased production of toys is split evenly between the two countries.
WINE
Exports (-)/
Imports (+)
Domestic
Consumption
1,400
1,400
(1,400)
5,600
7,000
Americo Industries - 2010

Problems 6 through 10 are based on Americo Industries. Americo is a U.S.-based multinational manufacturing firm, with wholly owned subsidiaries in
Brazil, Germany, and China, in addition to domestic operations in the United States. Americo is traded on the NASDAQ. Americo currently has 650,000
shares outstanding. The basic operating characteristics of the various business units are as follows:
U.S. Parent
Company
(US$)
$4,500
35%
------
Business Performance (000s, local currency)

Earnings before taxes (EBT)
Corporate income tax rate
Average exchange rate for the period
Brazilian
Subsidiary
(reais, R$)
R$6,250
25%
R$1.80/$
German
Subsidiary
(euros, )
4,500
40%
0.7018/$
Chinese
Subsidiary
(yuan, Y)
Y2,500
30%
Y7.750/$
Problem 1.6 Americo Industries' Consolidated Earnings

Americo must pay corporate income tax in each country in which it currently has operations.
a. After deducting taxes in each country, what are Americo's consolidated earnings and consolidated earnings per share in U.S. dollars?
b. What proportion of Americo's consolidated earnings arise from each individual country?
c. What proportion of Americo's consolidated earnings arise from outside the United States?
U.S. Parent
Company
(US$)
Business Performance (000s)

Earnings before taxes, EBT (local currency)
Less corporate income taxes
Net profits of individual subsidiary
4,500.00
(1,575.00)
2,925.00
35%
Avg exchange rate for the period (fc/$)

Net profits of individual subsidiary (US$)
-----$ 2,925.00
Consolidated profits (total across units)

Total diluted shares outstanding (000s)
$ 9,602.22
650.00
a. Consolidated earnings per share (EPS)
Brazilian
Subsidiary
(reais, R$)
25%
6,250.00
(1,562.50)
4,687.50
German
Subsidiary
(euros, )
40%
4,500.00
(1,800.00)
2,700.00
1.8000
$ 2,604.17
0.7018
$ 3,847.25
27.1%
40.1%
Chinese
Subsidiary
(yuan, Y)
2,500.00
(750.00)
1,750.00
30%
7.7500
225.81
14.77
b. Proportion of total profits originating

by country
30.5%
c. Proportion of total profits originating

from outside the United States
69.5%
2.4%
Problem 1.7 Americo's EPS Sensitivity to Exchange Rates (A)

Assume a major political crisis racks Brazil, first affecting the value of the Brazilian reais and, subsequently, inducing an economic recession within the
country. What would be the impact on Americo's consolidated EPS if the Brazilian reais were to fall in value to R$3.00/$, with all other earnings and exchange
rates remaining the same?
U.S. Parent
Company
(US$)

4,500.00
(1,575.00)
2,925.00
35%

Brazilian
Subsidiary
(reais, R$)
-----2,925.00

9,602.22
650.00
Baseline earnings per share (EPS)
14.77
6,250.00
(1,562.50)
4,687.50
25%
German
Subsidiary
(euros, )
4,500.00
(1,800.00)
2,700.00
40%
1.8000
2,604.17
Chinese
Subsidiary
(yuan, Y)
2,500.00
(750.00)
1,750.00
30%
0.7018
3,847.25
7.7500
225.81
Brazilian reais falls in value against the U.S. dollar

U.S. Parent
Company
(US$)

4,500.00
(1,575.00)
2,925.00
35%
-----2,925.00

8,560.56
650.00
"New" earnings per share (EPS)
13.17
EPS change from baseline:
-10.8%
Brazilian
Subsidiary
(reais, R$)
6,250.00
(1,562.50)
4,687.50
25%
3.0000
1,562.50
German
Subsidiary
(euros, )
4,500.00
(1,800.00)
2,700.00
40%
0.7018
3,847.25
Chinese
Subsidiary
(yuan, Y)
2,500.00
(750.00)
1,750.00
30%
7.7500
225.81
Problem 1.8 Americo's EPS Sensitivity to Exchange Rates (B)

Assume a major political crisis racks Brazil, first affecting the value of the Brazilian reais and, subsequently, inducing an economic recession within the
country. What would be the impact on Americo's consolidated EPS if, in addition to the fall in the value of the reais to R$3.00/$, earnings before taxes in Brazil
fell as a result of the recession to R$5,8000,000?

35%

U.S. Parent
Company
(US$)
Brazilian
Subsidiary
(reais, R$)
German
Subsidiary
(euros, )
Chinese
Subsidiary
(yuan, Y)
4,500.00
(1,575.00)
2,925.00
6,250.00
(1,562.50)
4,687.50
4,500.00
(1,800.00)
2,700.00
2,500.00
(750.00)
1,750.00
25%
-----2,925.00

9,602.22
650.00
14.77
40%
1.8000
2,604.17
30%
0.7018
3,847.25
7.7500
225.81
Brazilian reais falls in value against the U.S. dollar and Americo's Brazilian sales decline
U.S. Parent
Company
(US$)

4,500.00
(1,575.00)
2,925.00
35%
-----2,925.00

8,448.06
650.00
Revised earnings per share (EPS)
13.00
Change in EPS from both changes:
-12.0%
Brazilian
Subsidiary
(reais, R$)
5,800.00
(1,450.00)
4,350.00
25%
3.0000
1,450.00
German
Subsidiary
(euros, )
4,500.00
(1,800.00)
2,700.00
40%
0.7018
3,847.25
Chinese
Subsidiary
(yuan, Y)
2,500.00
(750.00)
1,750.00
30%
7.7500
225.81
Problem 1.9 Americo's Earnings and the Fall of the Dollar

The U.S. dollar has experienced significant swings in value against most of the world's currencies in recent years.
a. What would be the impact on Americos consolidated EPS if all foreign currencies were to appreciate 20% against the U.S. dollar?
b. What would be the impact on Americos consolidated EPS if all foreign currencies were to depreciate 20% against the U.S. dollar?
Baseline exchange rate (fc/$)
Percent change (+ appreciation, - depreciation)
New exchange rate (fc/$)
Appreciation Case
1.8000
20%
1.5000
0.7018
20%
0.5848
7.7500
20%
6.4583
U.S. Parent
Company
(US$)
Brazilian
Subsidiary
(reais, R$)
German
Subsidiary
(euros, )
Chinese
Subsidiary
(yuan, Y)
4,500.00
(1,575.00)
2,925.00
35%

-----
-----2,925.00

10,937.67
650.00
14.77
EPS if foreign currencies appreciate
16.83
Baseline exchange rate (fc/$)

Percent change (+ appreciation, - depreciation)
New exchange rate (fc/$)
Depreciation Case
4,500.00
(1,800.00)
2,700.00
40%
1.5000
3,125.00
EPS has changed by:
2,500.00
(750.00)
1,750.00
30%
0.5848
4,616.70
6.4583
270.97
13.9%
-----
1.8000
-20%
2.2500
0.7018
-20%
0.8773
7.7500
-20%
9.6875
U.S. Parent
Company
(US$)
Brazilian
Subsidiary
(reais, R$)
German
Subsidiary
(euros, )
Chinese
Subsidiary
(yuan, Y)
4,500.00
(1,575.00)
2,925.00
35%
6,250.00
(1,562.50)
4,687.50
25%
-----2,925.00

8,266.78
650.00
14.77
EPS if foreign currencies depreciate
12.72
6,250.00
(1,562.50)
4,687.50
25%
2.2500
2,083.33
EPS has changed by:
4,500.00
(1,800.00)
2,700.00
40%
0.8773
3,077.80
-13.9%
2,500.00
(750.00)
1,750.00
30%
9.6875
180.65
Problem 1.10 Americo's Earnings and Global Taxation

All MNEs attempt to minimize their global tax liabilities. Return to the original set of baseline assumptions and answer the following questions regarding
Americos global tax liabilities:
a. What is the total amount in U.S. dollars that Americo is paying across its global business in corporate income taxes?
b. What is Americo's effective tax rate (total taxes paid as a proportion of pre-tax profit)?
c. What would be the impact on Americos EPS and global effective tax rate if Germany instituted a corporate tax reduction to 28%, and Americos earnings
before tax in Germany rose to 5,000,000?
U.S. Parent
Company
(US$)

4,500.00
(1,575.00)
2,925.00
35%

Brazilian
Subsidiary
(reais, R$)
-----2,925.00

9,602.22
650.00
Consolidated earnings per share (EPS)
14.77
Tax payments by country in US dollars
1,575.00
a. Total global tax bill, US$
5,104.66
6,250.00
(1,562.50)
4,687.50
25%
German
Subsidiary
(euros, )
4,500.00
(1,800.00)
2,700.00
40%
Chinese
Subsidiary
(yuan, Y)
2,500.00
(750.00)
1,750.00
30%
1.8000
2,604.17
0.7018
3,847.25
7.7500
225.81
868.06
2,564.83
96.77
3,472.22
6,412.08
322.58
b. What is Americo's effective tax rate?

EBT by country, US$
4,500.00
Consolidated EBT
Total tax bill
Effective tax rate
$
$
14,706.89
5,104.66
34.7%
c. What would be the impact on Americo's EPS and global effective tax rate if Germany instituted a tax cut to 28%, and German subsidiary earnings
rose to 5 million euros?
U.S. Parent
Brazilian
German
Chinese
Company
Subsidiary
Subsidiary
Subsidiary
(US$)
(reais, R$)
(euros, )
(yuan, Y)
4,500.00
(1,575.00)
2,925.00
35%
-----2,925.00
6,250.00
(1,562.50)
4,687.50
25%
5,000.00
(1,400.00)
3,600.00
28%
2,500.00
(750.00)
1,750.00
30%
1.8000
2,604.17
0.7018
5,129.67
7.7500
225.81

10,884.64
650.00
Consoldiated earnings per share (EPS)
16.75
4,500.00
3,472.22
7,124.54
322.58
1,575.00
868.06
1,994.87
96.77
$
$
15,419.34
4,534.70
29.4%
EBT by country, US$

Tax payments by country in US dollars
Consolidated EBT
Total tax bill
Effective tax rate

Comparative Advantage: Toys Wine Assumptions (Containers/unit) (Cases/unit)

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Comparative Advantage

Problem 1.1 Production and Consumption

Production if there is no trade

Total production and consumption across both countries

Problem 1.2 Specialization

Production if there is complete specialization

Problem 1.3 Trade at China's Domestic Price

Trade at China's domestic price (10 toys = 7 wine)

With complete specialization, toy production in total is increased as in Problem 2.

Problem 1.4 Trade at France's Domestic Price

Trade at France's domestic price (2 toys = 7 wine)

Problem 1.5 Trade at Negotiated Mid-Price

What happens to total production and consumption?

Trade at Negotiated Mid-Price (6 toys = 7 wine)

Americo Industries - 2010

Business Performance (000s, local currency)

Problem 1.6 Americo Industries' Consolidated Earnings

Business Performance (000s)

Avg exchange rate for the period (fc/$)

Consolidated profits (total across units)

a. Consolidated earnings per share (EPS)

b. Proportion of total profits originating

c. Proportion of total profits originating

Problem 1.7 Americo's EPS Sensitivity to Exchange Rates (A)

Business Performance (000s)

Avg exchange rate for the period (fc/$)

Consolidated profits (total across units)

Baseline earnings per share (EPS)

Brazilian reais falls in value against the U.S. dollar

Business Performance (000s)

Consolidated profits (total across units)

"New" earnings per share (EPS)

EPS change from baseline:

Problem 1.8 Americo's EPS Sensitivity to Exchange Rates (B)

Business Performance (000s)

Avg exchange rate for the period (fc/$)

Consolidated profits (total across units)

Baseline earnings per share (EPS)

Business Performance (000s)

Consolidated profits (total across units)

Revised earnings per share (EPS)

Change in EPS from both changes:

Problem 1.9 Americo's Earnings and the Fall of the Dollar

Avg exchange rate for the period (fc/$)

Consolidated profits (total across units)

Baseline earnings per share (EPS)

EPS if foreign currencies appreciate

Baseline exchange rate (fc/$)

EPS has changed by:

Consolidated profits (total across units)

Baseline earnings per share (EPS)

EPS if foreign currencies depreciate

EPS has changed by:

Problem 1.10 Americo's Earnings and Global Taxation

Business Performance (000s)

Avg exchange rate for the period (fc/$)

Consolidated profits (total across units)

Consolidated earnings per share (EPS)

Tax payments by country in US dollars

a. Total global tax bill, US$

b. What is Americo's effective tax rate?

Consolidated profits (total across units)