Identify the financial decisions facing a multinational firm, compare and analyze the foreign exchange risks facing a multinational corporation. Help explain the role of derivatives in hedging the foreign currency risk.
1. Rolls-Royce, the British jet engine manufacturer, sells engines to U.S. airlines and buys parts from U.S. companies. Suppose it has accounts receivable of $1.5 billion and accounts payable of $740 million. It also borrowed $600 million. The current spot rate is $1.512/pound.
a. What is Rolls-Royce's dollar transaction exposure in dollar terms? In pound terms?
b. Suppose the pound appreciates to $1.7642/pound. What is Rolls-Royce's gain or loss in pound terms, on its dollar transaction exposure?
2. Suppose that on January 1, American Golf's French subsidiary, Golf du France, had a balance sheet that showed current assets of FF 1 million; current liabilities of FF 300,000; total assets of FF 2.5 million and total liabilities of FF 900,000. On December 31, Golf du France's balance sheet in Frances was unchanged from the figures given above, but the Franc had declined in value from $0.1270 at the start of the year to $0.1180 at the end of the year. Under FASB-52, what is the translation amount to be shown on American Golf's equity account for the year if the Franc is the functional currency? How would your answer change if the dollar were the functional currency?
3. Midwestern Bank has lent $10 million to finance an equipment sale to Thailand by Lasertech, a major exporter located in Michigan. Both loans are priced in U.S. dollars.
a. Is Midwestern's loan to Lasertech exposed to exchange risk? Explain..
b. Suppose Midwestern has lent money to Lasertech secured by the general credit of the company. Are these loans exposed to exchange risk? Explain.
4. During 1993, the Japanese yen appreciated by 11% against the dollar. In response to the lower cost of the main imported ingredients?beef, cheese, potatoes, and wheat for burger buns?McDonald's Japanese affiliates reduces the price on certain set menus. For example, a cheeseburger, soda, and small order of French fries were marked down to 410 yen from 530 yen. Suppose the higher yen lowered the cost of ingredients for this mean by 30 yen.
a. How much of a volume increase is necessary to justify the price cut from 530 to 410 yen? Assume the previous profit margin (contribution to overhead) for this mean was 220 yen. What is the implied price elasticity of demand associated with this necessary rise in demand?
b. Suppose sales volume of this mean rises by 60%. What will be the percentage change in McDonald's dollar profits from this mean?
c. What other reasons might McDonald's have had for cutting price besides raising its profits?
5. Assess the likely consequences of a declining dollar on Fluor Corporation, the international construction-engineering contractor based in Irvine, California. Most of Fluor's value-added involves project design and management; most of its costs are for U.S. labor in design, engineering, and construction-management services.
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This posting provides detailed solutions to five questions based on identifying the financial decisions facing a multinational firm, comparing and analyzing the foreign exchange risks facing a multinational corporation and the role of derivatives in hedging foreign currency risk.