Question

25. Impact of Exchange Rates on MNC Value Olmsted Co. has small computer chips assembl Poland and transports the final assembled produ the parent, where they are sold by the parent in United States. The assembled products are invoiced dollars. Olmsted Co. uses Polish currency (the zlo produce these chips and assemble them in Poland.o ed in ucts to Polish subsidiary pays the employees in the local cur rency (zloty), and Olmsted Co. finances its subsidia operations with loans from a Polish bank (in zlot The parent of Olmsted will send sufficient monthl payments (in dollars) to the subsidiary in order to repay the loan and other expenses incurred by the subsidiary. If the Polish zloty depreciates against the dollar over time, will that have a favorable, unfavorable or neutral effect on the value of Olmsted Co.? Br explain. oty). Briefly

Answer 1

The solutions to the situation described above is in two parts. The first part is the revenue of the firm generated by selling computer chips. Finished Computer Chips are invoiced in dollars and hence are immune to the movement of zloty's value relative to the dollar. Hence, the firm's revenues remain the same irrespective of a downward or upward move in the zloty's value. However, the firm's interest (financing expense) expense and operational expense (workers' wages) are in zloty. These expenses will definitely be impacted by the movement in the zloty's value relative to the $.

If the zloty depreciated relative to the $, it implies that the firm can buy more zloty with the same amount of $. In other words, a fixed operational and financing expense in zloty would when converted into $ would be much less than before , if the zloty depreciates with respect to the $. Therefore, the firm's operational and financing expense will go down in $ terms and its revenuw will remain constant, This in turn would ensure that the firm's profit would increase owing to the zloty's depreciation and this phenomenon is beneficial to the firm.