Introduction
Possum Products CEO wants to expand the company to the international market, but different issues need to be addressed. The CEO wants to expand its geographic footprint in selling dried, low-fat smoked opossum, venison jerky snacks, and ostrich packs. The company has enjoyed success in the United States, but the expansion has to be done in steps to adapt to challenges. The CFO has plans to adopt strategic techniques to avoid additional risk and navigate the challenges of expanding the company. This report explains the essentials of multinational financial management.
Analysis
One of the significant considerations the company is supposed to make is the convertibility of currency and conversion rates. While Possum Inc. wants to become a multinational corporation, it is expected to know the nature of the local currency of the host currency and its conversion rates. A multinational corporation is a business that operates in more than one country and is integrated via separate established entities. Companies expand in order to seek cheap labor, widen the market, acquire raw materials, explore new technology and diversify (Zhao, 2017). Multinational operations are different from domestic businesses due to differences in currency denominations, cultural differences, political risk, and legal and economic complications. Therefore, the exchange rates and stability of the currency may directly impact the operations of the company, either positively or negatively.
Direct quotation is a crucial direct foreign exchange between the U.S. and a foreign country in U.S. dollars. An indirect quotation is the foreign exchange of dollars expressed in a different foreign currency. And indirect quotation is calculated by finding the reciprocal of the direction quotation.
According to the table provided, the indirect quote of the dollar versus Euro is USD/EURO =1/1.25 =0.8. contrary, the direct quote for Kronor is SEK/USD = 1/7= 0.1429. The conversion of Euro to U.S. dollar direct quotation stands at 1.25, but this may differ when cross rates are involved.
Cross rates apply where the currency has to be converted to another currency, then converted to the U.S. dollar. An example is when francs are converted to Euros; then Euros are converted to U.S. dollars. A cross rate between Euros and kronor can be calculated as follows:
- Cross Rate = (kronor/Dollar) x (Dollars/Euro) = 7.000* 1.2500 =8.75 Kronor/Euro
- Euros/Krona cross rate is calculated as the reciprocal of the Kronor/Euro
Therefore, cross-rate = 1 divided by (8.75) = 0.1142
The exchange rates can impact the price of a company’s assets, cash flow, profits, and financial structure (Epstein, 2019). When the company wants to sell a package of jerky and ship to France at $1.75 and make 50% on the product, it will sell at ($1.75) (1.50) = $2.625. When this is converted into France currency, it will be o $2.625/$1.25 = 2.10 euros.
When the company produces a jerky package in France at 2 Euros and sells it at 20 Kronor, the dollar profit can be calculated through the cross-rate exchange value for kronor which is 8.75 kronor per Euro. So, the cost of production and shipping will be 8.75 x 2 = 17.50 kronor. Therefore, a unit will be sold at 20 kronor earning a profit of 2.5 Kronor per unit. Considering that there are 0.1429 dollars per kronor, the profit per unit will be 2.5(.1429) = $.36 U.S.
Solution
Possum Products is to comprehend to pose an impact on the economies of scale through the world market. Such an impact must involve controlling supply and demand in the floating system in order to set the price. This is what the company has been doing since its establishment in 1971. Before 1971, the international monetary system operated in a fixed exchange rate where U.S. was referred to as the “gold standard” because its value was based on gold. Other currencies were tied to the value of the dollar, which was fixed at $35 per ounce of gold. The fixed exchange system was abandoned in 1973 because countries realized it was extremely hard to maintain. The current system is the floating exchange rate which allows fluctuation of currencies depending on demand and supply as well as government interventions. The company will evaluate how different currencies can be converted and their exchange rates to enable trading on a global level. A convertible currency is one that exchanges with other currencies at prevailing international market rates. When a currency is non-convertible, the company will have challenges making its entry into such regions due to challenges that affect such currencies (De Rambures & Duenas, 2017). Additionally, possum products will need to understand spot rate and currency value relationships for effective currency valuation.
Another issue in dealing with currency exchange rates is understanding parity or ensuring prices of products are similar in different countries that use different currencies. Purchasing power parity involves converting currencies or adjusting exchange rates to ensure similar goods cost the same in different countries. Interest rate parity allows investors to earn a similar amount in different countries (Bräuning & Puria, 2017). According to the information given in this assignment, 1 Euro= $1.25 within the 180-day forward market. The risk-free rate is 6% for and 4% in France; hence interest rate parity can be expressed as follows:
f t / e0 = (1+r h) / (1+r f)
Where Ft represents the forward exchange rate in a period while e0 represents the spot exchange rate, the periodic exchange rate of a foreign country is represented by rf while that of the home country is rh.
Spot rate is 1 euro to $1.25; rh = (6/2) % =3% in 180 days; Rt = (4/2) % in 180 days. The rate can be calculated as:
(Ft/spot rate) = (1+ rh)/(1+rh)
Ft = (1.03/1.02) × 1.25
Ft = $1.2623
Since the spot rate is 1.25, the parity does not hold, and the U.S. securities offer a higher return.
If a jerky package costs $2 in the U.S. and the purchasing power parity is applied to its sale in France, the price will be as follows:
Spot rate = Ph/Pt; where Ph and Pt represent periodic interest rates in home and host countries, respectively.
Therefore: $1.2500 = $2.00/Pt
Pt = $2.00/$1.25 = 1.60 euros
Problems associated with multination capital budgeting must be addressed to ensure currency fluctuations, political risk, taxes, and associated issues do not affect business operations. Relative inflation rates can change the interest rates and exchange rates. Therefore, a multinational corporation should be aware of the prevailing conditions concerning the inflation and stability of a country’s currency. Foreign currencies that have high inflation are likely to keep depreciating, which may cause losses of value to the assets of a multinational company.
In international markets, parity between any two countries changes depending on economic conditions, but adjustment can be initiated by controlling demand and supply. Exchange rate risk can pose a challenge to profitability because it occurs when there are fluctuations in exchange rates, which can negatively affect cash flow. Low inflation rates are crucial as an indication of currency stability which means the company will easily maintain the value of its assets over time.
Possum Products should evaluate the role of political or government involvement in controlling businesses in the host country. Capital structures vary depending on the host country’s behavior towards international trade and security. Some countries impose high taxes and strict control measures for products sold by multinational corporations, which may hinder profit-making objectives. Some countries are associated with high costs of expatriation and an increased risk of seizure of property belonging to multinational corporations (Tahir et al., 2020). Many countries against expatriation of earnings are likely to have currencies that are not convertible or difficult to convert. Some countries do not trade their currency in the world market; hence operating in such countries may pose a problem when expatriation of earnings is required. Another significant risk is terrorism which may target companies associated with the United States.
Budgeting for multinational corporations is challenged by several factors, including financial risks in the host country, taxes, and currency fluctuations. Multinational corporations may be subjected to restrictions, seizure of assets, huge taxes, and fines where governmental authorities are hostile. Poor economies in the host country may lead to inflation and losses due to the loss of value of assets (Tahir et al., 2020). Strict regulations of expatriation of earnings may hinder operation and profit-making attempts.
Multinational corporations experience complex issues in cash management, credit management, and inventory management due to differences in locations and operation requirements. Cash management or flow may be affected as a result of the distance between different branches, currency fluctuations, and difficulty in transfer logistics. Credit management is difficult due to differences in collection strategies and fluctuations in exchange rates (Arize et al., 2017). Inventory management is complex for multination firms because it involves transportation of goods, transportation costs, taxes, and import duties that are affected by exchange rate fluctuations.
Justification
- As Possum Products aims to expand to overseas markets, some issues must be approached with carefulness. These elements include cash flow, management, and currency considerations.
- Management of multinational corporations is different from that of domestic companies due to geographic spread.
- Cash flow is affected due to the company’s existence in distant locations that must communicate and operate as one. In addition, currency issues such as exchange rates, stability, and creditworthiness determination can be complex in new regions with different fiscal policies.
- The supply chain, including warehousing and inventory, is a crucial element because shipping logistics and costs determine the company’s success in a new environment.
- The corporation should ensure the host country’s cultural differences are considered by liaising with locals and conducting research to understand the market.
Conclusion
Global expansion for multinational corporations creates chances to diversify, increase profit margins and widen the worldwide market and coverage. On the contrary, the process is associated with other problems such as currency exchange rates and convertibility, culture, and political risk. Therefore, possum Products must evaluate major elements to address as it pursues the project of entering new markets. The most critical issues to address will include monitoring risk factors and positioning the company for success through strategic solutions.
References
Arize, A. C., Malindretos, J., & Igwe, E. U. (2017). Do exchange rate changes improve the trade balance: An asymmetric nonlinear cointegration approach. International review of economics & Finance, 49, 313-326.
Bräuning, F. & Puria, K. (2017). Uncovering covered interest parity: The role of bank regulation and monetary policy. Federal Reserve Bank of Boston research paper series current policy perspectives paper, (17-3).
De Rambures, D., & Duenas, F. E. (2017). An international non-convertible currency. In China’s financial system (pp. 163-178). Palgrave Macmillan, Cham.
Epstein, G. (2019). The role and control of multinational corporations in the world economy. In The Handbook of globalization, third edition. Edward Elgar Publishing.
Tahir, M., Ibrahim, H., Zulkafli, A. H., & Mushtaq, M. (2020). Influence of exchange rate fluctuations and credit supply on dividend repatriation policy of US multinational corporations. Journal of Central Banking Theory and Practice, 9(special issue), 267-290.
Zhao, J. (2017). Why Go Global? The Logic behind Investing Overseas. In from world Factory to global investor (pp. 156-162). Routledge.