INTERNATIONAL FINANCE Tutorial 5 Answers Chapter 10 10. Translation Exposure. Consider a period in which the U. S. dollar weakens against the euro. How will this affect the reported earnings of a U. S. -based MNC with European subsidiaries? Consider a period in which the U. S. dollar strengthens against most foreign currencies. How will this affect the reported earnings of a U. S. -based MNC with subsidiaries all over the world? ANSWER: The consolidated earnings will be increased due to the strength of the subsidiaries’ local currency (the euro).
The consolidated earnings will be reduced due to the weakness of the subsidiaries’ local currencies. 12. Economic Exposure. Longhorn Co. produces hospital equipment. Most of its revenues are in the United States. About half of its expenses require outflows in Philippine pesos (to pay for Philippine materials). Most of Longhorn’s competition is from U. S. firms that have no international business at all. How will Longhorn Co. be affected if the peso strengthens? ANSWER: If the peso strengthens, Longhorn will incur higher expenses when paying for the Philippine materials.
Because its competition is not affected in a similar manner, Longhorn Company is at a competitive disadvantage when the peso strengthens. 19. Comparing Transaction and Economic Exposure. Erie Co. has most of its business in the U. S. , except that it exports to Belgium. Its exports were invoiced in euros (Belgium’s currency) last year. It has no other economic exposure to exchange rate risk. Its main competition when selling to Belgium’s customers is a company in Belgium that sells similar products, denominated in euros. Starting today, Erie Co. plans to adjust its pricing strategy to invoice its exports in U.
S. dollars instead of euros. Based on the new strategy, will Erie Co. be subject to economic exposure to exchange rate risk in the future? Briefly explain. ANSWER: Economic exposure still exists because a weak euro would encourage Belgian customers to switch to local competitors. Chapter 12 7. Limitations of Hedging Translation Exposure. Bartunek Co. is a U. S. -based MNC that has European subsidiaries and wants to hedge its translation exposure to fluctuations in the euro’s value. Explain some limitations when it hedges translation exposure. ANSWER: The limitations are as follows.
First, Bartunek Inc. needs to forecast its foreign subsidiary earnings and may forecast inaccurately. Thus, it will hedge against a level of foreign earnings that differs from actual foreign earnings. Second, forward contracts are not available for all currencies, although Bartunek will not be affected by this limitation since forward contracts in euros are available. Third, transaction exposure may be increased as a result of hedging translation exposure. 10. Comparing Degrees of Translation Exposure. Nelson Co. is a U. S. firm with annual export sales to Singapore of about S$800 million.
Its main competitor is Mez Co. , also based in the United States, with a subsidiary in Singapore that generates about S$800 million in annual sales. Any earnings generated by the subsidiary are reinvested to support its operations. Based on the information provided, which firm is subject to a higher degree of translation exposure? Explain. ANSWER: Since Nelson Company does not have any subsidiaries, its exposure to exchange rate fluctuations would not be classified as translation exposure. Conversely, Mez Company is subject to translation exposure. 11. Managing Economic Exposure. St. Paul Co. oes business in the United States and New Zealand. In attempting to assess its economic exposure, it compiled the following information. a. St. Paul’s U. S. sales are somewhat affected by the value of the New Zealand dollar (NZ$), because it faces competition from New Zealand exporters. It forecasts the U. S. sales based on the following three exchange rate scenarios: Revenue from U. S. Business Exchange Rate of NZ$(in millions) NZ$ = $. 48$100 NZ$ =. 50105 NZ$ =. 54110 b. Its New Zealand dollar revenues on sales to New Zealand invoiced in New Zealand dollars are expected to be NZ$600 million. . Its anticipated cost of materials is estimated at $200 million from the purchase of U. S. materials and NZ$100 million from the purchase of New Zealand materials. d. Fixed operating expenses are estimated at $30 million. e. Variable operating expenses are estimated at 20 percent of total sales (after including New Zealand sales, translated to a dollar amount). f. Interest expense is estimated at $20 million on existing U. S. loans, and the company has no existing New Zealand loans. Forecast net cash flows for St. Paul Co. under each of the three exchange rate scenarios. Explain how St.
Paul’s projected net cash flows are affected by possible exchange rate movements. Explain how it can restructure its operations to reduce the sensitivity of its net cash flows to exchange rate movements without reducing its volume of business in New Zealand. ANSWER: Forecasted Net Cash Flows for St. Paul Company (Figures are in millions) NZ$ = $. 48 NZ$ = $. 50NZ$ = $. 54 Sales U. S. $100$105$110 New ZealandNZ$600 = 288NZ$600 = 300NZ$600 = 324 Total$388$405$434 Cost of materials U. S. $200$200$200 New ZealandNZ$100 = 48NZ$100 = 50NZ$100 = 54 Total$248$250$254 Operating expenses U.
S. : Fixed$30$30$30 U. S. : Variable (20% of total sales)788187 Total$108$111$117 Interest expense U. S. $20$20$20 New ZealandNZ$0 =0NZ$0 =0NZ$0 =0 Total$20$20$20 Net Cash Flows$12$24$43 The forecasted income statements show that St. Paul Company is favorably affected by a strong New Zealand dollar (since its NZ$ inflow payments exceed its NZ$ outflow payments). St. Paul Company could reduce its economic exposure without reducing its New Zealand revenues by shifting expenses from the U. S. to New Zealand. In this way, its NZ$ outflow payments would be more similar to its NZ$ inflow payments.
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International Finance Essay. (2016, Nov 13). Retrieved from https://graduateway.com/international-finance-essay/