Question

Assuming today was 1" January 2019. You are the chief financial officer of a US-based company which manufactures and distributes office supplies. As the competition in local market was getting stiffer despite the company's strong customer base, the Board of Directors (the Board) considering for the company to expand its international business by penetrating to either the Canadian market or Mexican market through exporting. The company anticipates strong demand for office supplies in these two markets. Required: You are responsible for developing contingency plan as the selected market will impose trade barriers over time. The board is in favour of establishing a subsidiary in the country of concern under such conditions. Argue whether this plan is reasonable. Are there obvious reasons for the plan to fail? (5 marks)

Answer 1

Establishment of a subsidiary in another country like Canadian markets for Mexican markets will help the company in order to avoid the the transaction risk to a large possible extent because transaction risk will be mostly get absorbed in the books of its subsidiaries whereas it will be exposed to the translation Risk in which the translation of book of subsidiary company would be have to be done in books of parents entity.

I will be trying to to develop a plan in order to increase the overall sales in those two countries but I will be also trying to avoid any kind of transaction risk due to depreciation of dollars in this country so I will be trying to establish a subsidiary or I may try to enter into a joint venture operate through branches but operation through joint venture and branches will mean that the company will have to get exposed to the transaction risk and they cannot incorporate those subsidiaries books into the books of accounts of the main entity as they are not holding more than 50% of the shares and hence they will be exposed highly to the transaction risk and they cannot record translation risk by converting those figures into the books of account. it can be said that I will be trying to emphasize more on establishment of a subsidiary because establishment of subsidiary will mean that the company can also negate well with the trade barriers as subsidiaries will be having the home country advantage as well.

And hence it can be said that establishment of subsidiaries are better than establishment of branches or doing business through joint ventures or other business collaboration is because subsidiaries will be treated as separate entity in the home country and they will be helpful in order to avoid with fluctuations due to trade barriers and they can help in order to maximize its overall rate of return by management of the transaction risk as well.