Copper Suppliers, Inc. (CS), is a distributor of commercial grade copper. CS purchases copper directly from copper mines and then after refining it, sells the refined copper to industrial users-mostly electronics manufacturers. For our purposes, assume the refining process is virtually costless for CS. CS purchases copper quarterly from its suppliers and sells it within a few days of purchase to its customers. In a typical quarter, the purchase price of commercial copper is $1.50 per ounce, and the selling price is $2.00 per ounce. CS prefers to maintain this $0.50 profit per ounce of copper. On July 1, CS is deciding what action to take for the purchase and sale of copper on October 1. The July 1 spot price of unrefined copper is $1.50 per ounce. Because copper prices have been relatively stable in recent years, the futures price of October 1 unrefined copper is also $1.50 per ounce.
Required:
i.) Assume that the selling price for refined copper is has been "sticky" in recent years because of intense competition among copper distributors. Thus, CS knows that it will face a selling price of $2.00 on October 1. However, CS does not know what they will have to pay to buy unrefined copper on that same date.
a) What is CS's optimal decision? Should they use derivatives? Why? If so, how?
b) Assume the October 1 price of unrefined copper rose to $1.75 per ounce because of a production shortage in Brazil. Show any and all relevant journal entries on July 1 and October 1 relating to purchases of unrefined copper, derivatives contracts (if any) and sale of one ounce refined copper. You can assume the refined copper is sold on October 1.
ii) Assume the same facts in (i), part (b) except that:
• the October 1 price of refined copper is determined by the October 1 price of unrefined copper. In particular, assume the refined copper price will reflect a constant markup of $0.50 per ounce;
• CS has a firm commitment of $1.50 per ounce from its supplier for delivery of unrefined copper on October 1.
What should CS do now? Why? Show any and all relevant journal entries on July 1 and October 1 relating to purchases of unrefined copper, derivatives contracts (if any) and sale of one ounce refined copper. You can assume the refined copper is sold on October 1.