I came across this question and the answer explanation makes no sense. I am hoping that someone can help me understand.
The relevant part of the vignette:
“The US Dollar weakend against the euro by 4% and 50% of the sales occurred in the US”
The question:
"[Talking about a European firm] Which of the following is the most appropriate use of the reminder about the US versus euro exchange rate? The analyst should use the information:
to confirm that organic growth was less than 11.2% (PS: note that YoY earnings grew 11.2%)
when evaluating management’s historical performance
the third option is irrelevant"
So I thought the answer should be 1. because although NI grew by 11.2%, its real growth was lower in euro terms. The '‘correct’ answer was 2. below is the explanation given:
“analyst should consider the foreign currency effect on sales growth for evaluating management’s historical performance. Foreign currency fluctuations are out of management’s control, so management should not be held accountable for the fluctuations when evaluating their performance.”
Don’t the two sentences in the answer explanation contradict each other?? What is the correct answer? Should currency fluctuations be considered in management performance evaluation?
They don’t contradict- analyst should consider (have in mind) and use the information in order to isolate the management’s performance from currency rates fluctations.
What this is making you think about is the effect that translation of foreign currency sales have on the revenue line on the income statement.
In this case the sales figures reported on the income statement has been adversely affected by the weakning of the dollar when the reporting currency is the euro. This has led to lower sales figures because 50% of the company’s sales are denominated in dollars.
This decrease in sales as a result of currency movement is outside managements control and therefore the analyst has to factor this into their analysis.
So if you’re looking at a 5-year history of sales of a company that reports in euro’s but has 50% of its sales denominated in dollars you can’t automatically assume that an increase or decline is due to management’s poor or superior performance, you have to factor in the currency affect as well.
ok that makes sense. Currency fluctuations should not be held against the management therefore that factor is an input to management performance (good or bad).
No, the exact opposite is true. Had the exchange rate remained the same as the prior year, current year sales would have been higher resulting in sales growth of MORE than 11.2%.