Chapter 18 International Managerial Finance

818 PART SIX Special Topics in Managerial Finance
EXAMPLE
Adjustments in Operations
In responding to exchange rate fluctuations, MNCs can give their international
cash flows some protection through appropriate adjustments in assets and liabilities.
Two routes are available to a multinational company. The first centers on
the operating relationships that a subsidiary of an MNC maintains with other
firms—third parties. Depending on management’s expectation of a local currency’s
position, adjustments in operations would involve the reduction of liabilities
if the currency is appreciating or the reduction of financial assets if it is
depreciating. For example, if a U.S.-based MNC with a subsidiary in Mexico
expects the Mexican currency to appreciate in value relative to the U.S. dollar,
local customers’ accounts receivable would be increased and accounts payable
would be reduced if at all possible. Because the dollar is the currency in which the
MNC parent will have to prepare consolidated financial statements, the net result
in this case would be favorably to increase the Mexican subsidiary’s resources in
local currency. If the Mexican currency were instead expected to depreciate, the
local customers’ accounts receivable would be reduced and accounts payable
would be increased, thereby reducing the Mexican subsidiary’s resources in the
local currency.
The second route focuses on the operating relationship a subsidiary has with
its parent or with other subsidiaries within the same MNC. In dealing with
exchange rate risks, a subsidiary can rely on intra-MNC accounts. Specifically,
undesirable exchange rate exposures can be corrected to the extent that the subsidiary
can take the following steps:
1. In appreciation-prone countries, intra-MNC accounts receivable are collected
as soon as possible, and payment of intra-MNC accounts payable is
delayed as long as possible.
2. In depreciation-prone countries, intra-MNC accounts receivable are collected
as late as possible, and intra-MNC accounts payable are paid as soon
as possible.
This technique is known as “leading and lagging” or simply as “leads and lags.”
Assume that a U.S.-based parent company, American Computer Corporation
(ACC), both buys parts from and sells parts to its wholly owned Mexican subsidiary,
Tijuana Computer Company (TCC). Assume further that ACC has
accounts payable of $10,000,000 that it is scheduled to pay TCC in 30 days and,
in turn, has accounts receivable of (Mexican peso) MP 115.00 million due from
TCC within 30 days. Because today’s exchange rate is MP 11.50/US$, the
accounts receivable are also worth $10,000,000. Therefore, parent and subsidiary
owe each other equal amounts (though in different currencies), and both
are payable in 30 days, but because TCC is a wholly owned subsidiary of ACC,
the parent has complete discretion over the timing of these payments.
If ACC believes that the Mexican peso will depreciate from MP 11.50/US$
to, say, MP 12.75/US$ during the next 30 days, the combined companies can
profit by collecting the weak currency (MP) debt immediately but delaying payment
of the strong currency (US$) debt for the full 30 days allowed. If parent and
subsidiary do this, and the peso depreciates as predicted, the net result is that
the MP 115.00 million payment from TCC to ACC is made immediately and is
safely converted into $10,000,000 at today’s exchange rate, whereas the delayed