Exchange Rates and Performance Evaluation
A U.S.-based company, Global Products Inc., has wholly owned subsidiaries across the world. Global Products Inc. sells products linked to major holidays in each country.
The president and board members of Global Products Inc. believe that the managers of their wholly owned country-level subsidiaries are best motivated and rewarded with both annual salaries and annual bonuses. The bonuses are calculated as a predetermined percentage of pretax annual income.
Senora Larza, the president of Global Products of Mexico, has worked hard this year to make her Mexican subsidiary profitable. She is looking forward to receiving her annual bonus, which is calculated as a predetermined percentage of this year’s pretax annual income earned by Global Products of Mexico. A condensed income statement for Global Products of Mexico for the most recent year is as follows (amounts in thousands of pesos):
Sales | MXN 20,000 |
Expenses | 19,000 |
Pretax Income | MXN 1,000 |
The U.S. headquarters financial group translates each of its wholly owned subsidiary’s results into U.S. dollars for evaluation. After translating the Mexican pesos income statement into U.S. dollars, the condensed income statement for Global Products of Mexico is as follows (amounts in thousands of dollars):
Sales | US$6,000 |
Expenses | 6,600 |
Pretax Income | US$(600) |
Instructions
a. Calculate the bonus amount based on (1) the Mexican pesos-based Pretax Income and (2) the U.S. dollar-based Pretax Income. Translate the pesos-based bonus to U.S. dollars using a current exchange rate.
b. Calculate the average exchange rate used to translate the Mexican pesos income statement into the U.S. dollar statement for the categories: (1) Sales and (2) Expenses.
c. Refer to the answers in parts a and b. Use those answers to explain why or how Global Products of Mexico’s pretax income became a U.S.-dollar pretax loss.
d. Explain one reason why the dollar-based pretax income would be appropriate for evaluating Senora Larza and one reason why the pesos-based pretax income would be appropriate. Which would you choose and why?
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