Assessing Economic Exposure
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Alaska, Inc., plans to create and finance a subsidiary in Mexico that produces computer components at a low cost and export them to other countries. It has no other international business. The subsidiary will produce computers and export them to Caribbean islands and will invoice the products in US dollars. The value of the currencies in the islands are expected to remain very stable against the dollar. The subsidiary will pay wages, rent, and other operating costs in Mexican pesos. The subsidiary will remit earnings to monthly to the parent.
A) Would Alaska's cash flows be favorable or unfavorably affected if the Mexican peso depreciates over time?
B) Assume that Alaska considers partial financing of this subsidiary with peso loans from Mexican Banks instead of providing all the financing with its own funds. Would this alternative form of financing increase, decrease, or have no effect on the degree to which Alaska is exposed to exchange rate movements of the peso?
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Solution Summary
The solution explains the impact on cash flows of a change in exchange rates
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A) Would Alaska's cash flows be favorable or unfavorably affected if the Mexican peso depreciates over time?
Alaska has cash outflows in Pesos and inflows in US Dollars. If peso depreciates over time, this would imply that there would be more pesos for the same dollars. The inflows when converted to pesos will increase. Given the ...
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