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International accounting: which foreign exchange rates to use; MBI acquisition?

1. Foreign exchange rates are used to establish budgets and track actual performance. Of the various exchange rate combinations which do you favor? Why? Is your view the same when you add local inflation to the budgeting process?

2. You are the CFO of Marisa corporation a major electronics manufacture head quartered in Shelton, Connecticut. To date your company's operations have been confined to the US and you are interested in diversifying your operations overseas. On option would be to begin establishing wholly owned subsidiaries in Europe and South America and Asia. Another option is to acquire a multinational company that already has a major international presence you are leaning toward the latter course of action as you are interested in diversifying your company's operation risk and enhancing its bottom line as soon as possible. You also have significant stock option package and will benefit greatly if the price of Marissa Corporation's common stock were to rise over the next year.

You are particularly interest in MBI International, as US based multinational with operations in a significant number of countries. You estimate that approximately 60% of the company' earnings are from abroad. Foreign operations performance statistics, provided in MBI corporation's consolidated financial statements are included in Exhibit 10-13 for the years 2004-2003 and 2002. Relevant notes are also appended.

Unfortunately MBI does not disclose data explaining the movement of the major currencies in which it conducts its business. You do a Google search and uncover a trade weighted index supplied by the US government. Given MBI's large scale operations you decide to use the trade weighted index as a proxy for MBI's currency experience (see exhibit 10-14). (In using such a proxy you are assuming that the currency mix of MBI's activities parallel the currency mix in the trade weighted index)

Required On the basis of the information provided does MBI represent an attractive acquisition candidate?

(See attached file for charts)

Notes non US subsidiaries that operate in a local currency environment account for about 90% of the company's non US revenue. The remaining 10% of the company's non US revenue is from subsidiaries and branches that operate in the US dollar area or whose economic environments are highly inflationary.

AS the value of the dollar weakens net assets recorded in local currencies translate into more US dollars than they would have at the previous year's rates. Conversely as the dollar becomes stronger net assets recorded in local currencies translate in fewer US dollars than they would have at the previous year's rates. The translation adjustments resulting from the translation of net assets amounted to $3,277 million at December 31, 2004, $1,698 million at December 31, 2003 and $1,917 million at December 31, 2002. The changes in translation adjustments since the end of 2002 are a reflection of the strengthening of the dollar in 2003 and the weakening of the dollar in 2004

Exhibit 10-14 Dollars trade weighted exchange index 2002-2004
2002-2004 (1990=100)

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Foreign exchange rates are used to establish budgets and track actual performance. Of the various exchange rate combinations which do you favor? Why? Is your view the same when you add local inflation to the budgeting process?

You are requested to think in the following terms: Foreign currency exchange rates and inflation are the two important external factors that are used for budgets and tracking actual performance. Although these variables are interrelated-for example, higher inflation in a specific country tends to drive the value of its currency down, which impacts the exchange rate-changes in currency exchange rates have the most effect on the budgeting process.

Changes in these two external factors emerge from several sources, including economic conditions, government policies, monetary systems, and political risks. You are encouraged to reflect on these: You may consider the following: Each factor is a important external variable affecting areas such as policy decisions, strategic planning, profit planning, and budget control. To minimize the possible negative impact of these factors company budgeting process must establish and implement policies and practices that recognize and respond to them. Other external forces such as political turmoil, competition, labor quality, and cultural or religious orientation of the local populace exist, but they tend to be related specifically to one country or particular region of the world.

You are encouraged to think in these terms: Movements in foreign exchange rates are explained by different theories but essentially are based on the underlying demand for assets denominated in a particular currency. So these are important for tracking performance and budgeting. Foreign exchange rate fluctuations affect a multinational through translation exposure, transaction exposure, and economic exposure. Each of these exposures has a different effect on the entire budgeting process.

You are encouraged to reflect on these: My favored functional currency combination is the US ...

Solution Summary

In a 1200+ word solution, the response is comprehensive and well cited. It provides good details about the questions and draws a conclusion about the MBI acquisition.

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