After completing the table below, answer the following questions.
a. Which city in the table is truly the cheapest date?
b. Which city in the table is the most expensive-cheap date?
c. If the exchange rate in Moscow on the Russian ruble (RUB) was 0.04200, instead of 0.0283, what would be the USD price?
d. If the exchange rate in Shangahi was CNY 6.66 = 1 USD, what would be its cost in USD and relative to a cheap date in New York City?
Cheap Date in Exchange Exchange Rate Cheap Date in Relative
Country City Local Currency Rate Quote 7 April 2014 In USD to NYC
Australia Sydney AUD 111.96 USD = 1 AUD 0.9290 104.01 112%
Brazil Rio de Janeiro BRL 135.43 USD = 1 BRL 0.4363 59.09 63%
Canada Ottawa CAD 78.33 USD = 1 CAD 0.9106 71.33 77%
Problem 1.1 Comparing Cheap Dates Around the World
Comparison of prices or costs across different country and currency environments requires the translation of the local currency into
a single common currency. This is most meaningful when the comparison is for the identical or near-identical product or service
across countries. Deutsche Bank has recently started publishing a comparison of cheap dates — and evening on the town for two to
eat at McDonald’s, see a movie, and drink a beer. Once all costs are converted to a common currency, the U.S. dollar in this case,
the cost of the date can be compared across cities relative to the base case of a cheap date in USD in New York City.
Japanese Britih European Chinese Russian
United States
Net Income Subsidiary Subsidiary Subsidiary Subsidiary Subsidiary Subsidiary
2013 JPY 1,500 GBP 100.00 EUR 204.00 CNY 168.00 RUB 124.00 USD 360.00
2014 JPY 1,460 GBP 106.40 EUR 208.00 CNY 194.00 RUB 116.00 USD 382.00
The average exchange rate for each year, by currency pairs, was the following. Use this data to answer the following questions.
Exchange Rate JPY = 1 USD USD = 1 GBP USD = 1 EUR CNY = 1 USD RUB = 1 USD USD
2013 97.57 1.5646 1.3286 6.1484 31.86 1.0000
2014 105.88 1.6473 1.3288 6.1612 38.62 1.0000
a. What was Blundell Biotech’s consolidated profits in U.S. dollars in 2013 and 2014?
b. If the same exchange rates were used for both years, what was the change in corporate earnings on a “constant currency” basis?
Blundell Biotech is a U.S.-based biotechnology company with operations and earnings in a number of foreign countries. The
company’s profits by subsidiary, in local currency (in millions), are shown in the following table for 2013 and 2014.
Problem 1.2 Blundell Biotech
a. Consolidated profits or earnings is found by consolidating the converted profits in each foreign currency to U.S. dollars for that period. (This
Japanese Britih European Chinese Russian
United States
Japanese Britih European Chinese Russian
United States
On a constant currency basis, all subsidiaries showed growth in profits except for the Japanese and Russian subsidiaries. Fortunately for
Blundell, neither of those subsidiaries is a major contributor to total profits.
c. Blundell Biotech’s consolidated earnings grew 5.7%. Since 4.9% of that was on an actual results basis (using constant currency assumption),
the exchange rate-based change in earnings can be solved for:
is simplified. Actual accounting practices would require the additional netting of any intra-company transactions resulting to eliminate any
double-counting of profits.)
Toys Wine
Assumptions (containers/unit) (cases/unit)
China — output per unit of production input 10 7
Comparative Advantage
Problems 1-5 illustrate an example of trade induced by comparative advantage. They assume that China and France
each have 1,000 production units. With one unit of production (a mix of land, labor, capital, and technology), China
can produce either 10 containers of toys or 7 cases of wine. France can produce either 2 cases of toys or 7 cases of
wine. Thus, a production unit in China is five times as efficient compared to France when producing toys, but equally
efficient when producing wine. Assume at first that no trade takes place. China allocates 800 production units to
building toys and 200 production units to producing wine. France allocates 200 production units to building toys and
800 production units to producing wine.
What is the production and consumption of China and France without trade?
Problem 1.3 Production and Consumption
Toys Wine
Assumptions (containers/unit) (cases/unit)
China — output per unit of production input 10 7
Problem 1.4 Specialization
Assume complete specialization, where China produces only toys and France produces only wine. What would be the
effect on total production?
Toys Wine
Assumptions (containers/unit) (cases/unit)
China — output per unit of production input 10 7
Problem 1.5 Trade at China’s Domestic Price
China’s domestic price is 10 containers of toys equals 7 cases of wine. Assume China produces 10,000 containers of toys and exports 2,000 to France. Assume France produces 7,000
cases of wine and exports 1,400 cases to China. What happens to total production and consumption?
France — output per unit of production input 2 7
China — total production inputs 1,000
France — total production inputs 1,000
Allocated production units to 1,000 –
Produces and consumes (output per unit x units allocated) 10,000 (2,000) 8,000 – 1,400 1,400
Allocated production units to – 1,000
Produces and consumes (output per unit x units allocated) – 2,000 2,000 7,000 (1,400) 5,600
benefits of trade have gone to France.
Toys Wine
Assumptions (containers/unit) (cases/unit)
China — output per unit of production input 10 7
Problem 1.6 Trade at France’s Domestic Price
France’s domestic price is 2 containers of toys equals 7 cases of wine. Assume China produces 10,000 containers of toys and exports 400 containers to France. Assume France in turn
produces 7,000 cases of wine and exports 1,400 cases to China. What happens to total production and consumption?
France — output per unit of production input 2 7
China — total production inputs 1,000
France — total production inputs 1,000
Allocated production units to 1,000 –
Produces and consumes (output per unit x units allocated) 10,000 (400) 9,600 – 1,400 1,400
Allocated production units to – 1,000
Produces and consumes (output per unit x units allocated) – 400 400 7,000 (1,400) 5,600
same as before trade. Thus the full benefit of trade goes to China when trading at France’s domestic prices.
The mid-price for exchange between France and China can be calculated as follows:
Toys Wine
Assumptions (containers/unit) (cases/unit)
China — output per unit of production input 10 7
France — output per unit of production input 2 7
China — total production inputs 1,000
France — total production inputs 1,000
What happens to total production and consumption?
Toy Exports (-)/ Domestic Wine Exports (-)/ Domestic
Trade at Negotiated Mid-Price (6 toys = 7 wine) Production Imports (+) Consumption Production Imports (+) Consumption
CHINA
Problem 1.7 Trade at Negotiated Mid-Price
TOYS
WINE
Allocated production units to 1,000 –
Produces and consumes (output per unit x units allocated) 10,000 (1,200) 8,800 – 1,400 1,400
Allocated production units to – 1,000
Produces and consumes (output per unit x units allocated) – 1,200 1,200 7,000 (1,400) 5,600
China gains 800 more containers of toys (8,800 post-trade compared to 8,000 pre-trade), and enjoys the same level of wine consumption (1,400).
France gains 800 more containers of toys (1,200 post-trade compared to 400 pre-trade), and enjoys the same level of wine consumption (5,600).
Wine production therefore remains the same as before trade, but now the 1,600 increased production of toys is split evenly between the two countries.
b. What has been the impact on Peng’s margins from this pricing strategy?
Fixed Rmb Pricing of the PT350 Plasma Cutting Torch
Cost Margin Price Margin Average Rate Price Percent Chg
Year (Rmb) (Rmb) (Rmb) (percent) (Rmb/US$) (US$) in US$ Price
2007 16,000 2,000 18,000 11.1% 7.61 2,365 —
Problem 1.8 Peng Plasma Pricing
Peng Plasma is a privately held Chinese business. It specializes in the manufacture of plasma cutting torches. Over the past
eight years it has held the Chinese renminbi price of the PT350 cutting torch fixed at Rmb 18,000 per unit. Over that same
period it has worked to reduce costs per unit, but has struggled of late due to higher input costs. Over that same period the
renminbi has continued to be revalued against the U.S. dollar by the Chinese government. After completing the table – assuming
the same price in renminbi for all years – answer the following questions.
a. What has been the impact of Peng’s pricing strategy on the US$ price? How would you expect their U.S. dollar-based
customers to have reacted to this?
Vitro’s U.S. Sales Percent Annual Avg Rate Vitro’s U.S. Sales Percent
Year (millions of USD) Change MXN = 1 USD (millions of MXN) Change
2011 USD 820 MXN 12.80 MXN 10,496
Santiago, however, is a bit uncertain on having his bonus based on the Mexican peso values of U.S. sales. As a
close friend and colleague, what advice would you give him based on your completion of the table below?
Problem 1.9 Santiago Pirolta’s Compensation Agreement
Santiago Pirolta has accepted the Managing Director position for Vitro de Mexico’s U.S. operations. Vitro is a Mexico-
based manufacturer of flat and custom glass products. Much of its U.S. sales are based on a variety of bottle products,
both mass market (e.g., glass bottles for soft drinks and beer) as well as specialty products (high-end cosmetic bottles
with rare metal coloring and quality). He will live and work in the United States (Dallas, Texas) and wishes to be paid
in US dollars. Vitro has agreed that his base salary of USD350,000 will be paid in U.S. dollars, but Vitro wishes to tie
his annual performance bonus to the Mexican peso value of U.S. sales since Vitro consolidates all final results for
reporting to stockholders in Mexican pesos (MXN).
Based on Vitro’s U.S. sales, in both U.S. dollars and Mexican pesos, you should recommend that Santiago continue to
argue for his performance bonus to be based on the U.S. dollar value, not the translated Mexican peso value.
First, under the previous Managing Director, U.S. sales measured both ways was volatile. The volatility, however,
was larger in pesos than dollars. If that was the only concern, then it would only be up to Santiago to choose his ‘risk
tolerance’ — how much volatility he is willing to bear in his annual performance bonus.
dollar and the peso. And changes in that exchange rate could potentially destroy all growth in U.S. sales (and his
bonus) as it did in 2013. In 2013 U.S. sales grew (not much, but they grew), and he would have theoretically recieved
a bonus. But as measured in Mexican pesos in 2013, as a result of a fall in the value of the peso, his performance
would have not been positive — and probably so would be the value of his bonus.
Problem 1.10 Americo Industries’ Consolidate Earnings
U.S. Parent Brazilian German Chinese
Company Subsidiary Subsidiary Subsidiary
Business Performance (000s) (US$) (reais, R$) (euros, €) (yuan, Y)
Earnings before taxes, EBT (local currency) 4,500.00 6,250.00 4,500.00 2,500.00
Problems 6 through 10 are based on Americo Industries. Americo is a U.S.-based multinational manufacturing firm, with wholly owned subsidiaries in
Brazil, Germany, and China, in addition to domestic operations in the United States. Americo is traded on the NADSAQ. Americo currently has 650,000
shares outstanding. The basic operating characteristics of the various business units is as follows:
Americo Industries – 2010
Americo must pay corporate income tax in each country in which it currently has operations.
a. After deducting taxes in each country, what are Americo’s consolidated earnings and consolidated earnings per share in U.S. dollars?
b. What proportion of Americo‘s consolidated earnings arise from each individual country?
c. What proportion of Americo‘s consolidated earnings arise from outside the United States?
Business Performance (000s, loccal currency) (US$) (reais, R$) (euros, €) (yuan, Y)
U.S. Parent Brazilian German Chinese
Company Subsidiary Subsidiary Subsidiary
Business Performance (000s) (US$) (reais, R$) (euros, €) (yuan, Y)
Earnings before taxes, EBT (local currency) 4,500.00 6,250.00 4,500.00 2,500.00
Less corporate income taxes 35% (1,575.00) 25% (1,562.50) 40% (1,800.00) 30% (750.00)
Problem 1.11 Americo’s EPS Sensitivity to Exchange Rates (A)
Assume a major political crisis wracks Brazil, first affecting the value of the Brazilian reais and, subsequently, inducing an economic recession within the country.
What would be the impact on Americo’s consolidated EPS if the Brazilian reais were to fall in value to R$3.00/$, with all other earnings and exchange rates
remaining the same?
Business Performance (000s) (US$) (reais, R$) (euros, €) (yuan, Y)
Less corporate income taxes 35% (1,575.00) 25% (1,562.50) 40% (1,800.00) 30% (750.00)
U.S. Parent Brazilian German Chinese
Company Subsidiary Subsidiary Subsidiary
Business Performance (000s) (US$) (reais, R$) (euros, €) (yuan, Y)
Earnings before taxes, EBT (local currency) 4,500.00 6,250.00 4,500.00 2,500.00
Less corporate income taxes 35% (1,575.00) 25% (1,562.50) 40% (1,800.00) 30% (750.00)
Assume a major political crisis wracks Brazil, first affecting the value of the Brazilian reais and, subsequently, inducing an economic recession within the
country. What would be the impact on Americo’s consolidated EPS if, in addition to the fall in the value of the reais to R$3.00/$, earnings before taxes in Brazil
fell as a result of the recession to R$5,8000,000?
Problem 1.12 Americo’s EPS Sensitivity to Exchange Rates (B)
Business Performance (000s) (US$) (reais, R$) (euros, €) (yuan, Y)
Less corporate income taxes 35% (1,575.00) 25% (1,450.00) 40% (1,800.00) 30% (750.00)
Change in EPS from both changes: -12.0%
Baseline exchange rate (fc/$) —– 1.8000 0.7018 7.7500
Percent change (+ appreciation, – depreciation) 20% 20% 20%
New exchange rate (fc/$) 1.5000 0.5848 6.4583
Appreciation Case U.S. Parent Brazilian German Chinese
Company Subsidiary Subsidiary Subsidiary
Business Performance (000s) (US$) (reais, R$) (euros, €) (yuan, Y)
Earnings before taxes, EBT (local currency) 4,500.00 6,250.00 4,500.00 2,500.00
Problem 1.13 Americo’s Earnings and the Fall of the Dollar
The U.S. dollar has experienced significant swings in value against most of the world’s currencies in recent years.
a. What would be the impact on Americo’s consolidated EPS if all foreign currencies were to appreciate 20% against the U.S. dollar?
b. What would be the impact on Americo’s consolidated EPS if all foreign currencies were to depreciate 20% against the U.S. dollar?
Depreciation Case U.S. Parent Brazilian German Chinese
U.S. Parent Brazilian German Chinese
Company Subsidiary Subsidiary Subsidiary
Business Performance (000s) (US$) (reais, R$) (euros, €) (yuan, Y)
Earnings before taxes, EBT (local currency) 4,500.00 6,250.00 4,500.00 2,500.00
b. What is Americo’s effective tax rate?
EBT by country, US$ 4,500.00$ 3,472.22$ 6,412.08$ 322.58$
U.S. Parent Brazilian German Chinese
Company Subsidiary Subsidiary Subsidiary
Business Performance (000s) (US$) (reais, R$) (euros, €) (yuan, Y)
Earnings before taxes, EBT (local currency) 4,500.00 6,250.00 5,000.00 2,500.00
Less corporate income taxes 35% (1,575.00) 25% (1,562.50) 28% (1,400.00) 30% (750.00)
c. What would be the impact on Americo’s EPS and global effective tax rate if Germany instituted a tax cut to 28% and German subsidiary earnings
rose to 5 million euros?
Problem 1.14 Americo’s Earnings and Global Taxation
All MNEs attempt to minimize their global tax liabilities. Return to the original set of baseline assumptions and answer the following questions regarding
Americo’s global tax liabilities:
a. What is the total amount – in U.S. dollars – which Americo is paying across its global business in corporate income taxes?
b. What is Americo’s effective tax rate (total taxes paid as a proportion of pre-tax profit)?
c. What would be the impact on Americo’s EPS and global effective tax rate if Germany instituted a corporate tax reduction to 28%, and Americo’s earnings
before tax in Germany rose to €5,000,000?