A U.S. firm owns a foreign subsidiary in France. In 2002, sales were EUR 1,000,000 and the USD/EUR exchange rate was 1.0620. In 2003, sales were EUR 1,100,000 and the exchange rate was 1.1417. What is the impact of the change in the value of the USD on the parent company’s translated sales? Sales will: A) increase by 7.5%. B) increase by 18.25%. C) decrease by 7.5%. D) decline by 18.25%. Your answer: B was incorrect. The correct answer was A) increase by 7.5%. The increase in sales due to the appreciating EUR is measured as 7.5% [= (1.1417 / 1.0620) − 1]. Sales for the subsidiary rose 10% [= (1,100,000 / 1,000,000) – 1] in the local currency (EUR). After translation the parent firm will report sales of USD 1,062,000 (= EUR 1,000,000 × 1.0620) for 2002 and USD 1,255,870 (= EUR 1,100,000 × 1.1417) for 2003. Growth measured from the parent’s perspective indicates sales rose 18.25% [= (1,255,870 / 1,062,000) − 1]. The 18.25% increase can also be calculated as the product of one plus the growth rate in sales measured in the local currency and one plus the rate of appreciation in the foreign currency, minus one, or (1.10 × 1.075) − 1 = 0.1825. The increase in the EUR results in a flow effect. ------------------------------------------------------------------------------------------------------------- I still do not understand why B, increase of 18.25%, isn’t the answer since they specifically asked for the change in the parent’s sales. Can someone elaborate? Thanks, dea
because they are asking for the increase in sales DUE to the EXCHANGE RATE. If the sales were EUR 1,000,000 the change in the translated sales would’ve been due only to the change in the value of the USD.
i Guess I jsut don’t think that the question is worded very well. I view the question as assuming the sales are constant then what is the effect of the change in exchange rate on the value. The 10% increase in sales is do to natural sales increase, but the 7.5% is due to exchange rates. Note that if this question were in the Economics section, the answer wouldn’t be as clear-cut. An increase in the exchange rate would decrease the relative amount of sales to firms within the EU to firms in the home country. You have to assume that all sales by the subsidiary are done within the country and that there is no import or export substitution effects. In other words, when the Euro became stronger, you would expect them to sell fewer goods abroad since they get more expensive. If the subsidiary only sells within the country, then there still can be effect if other companies with similar products can sell them in the domestic country since foreign goods become relatively cheaper. That’s just the more complicated Economics way to look at the question that I doubt would get asked.
jmh530, I think you are overanalyzing. This question doesn’t deal with impact of exchange rate on sales but rather translation issues of sales in foreign currencies.
I know I was overanalyzing. I was just pointing out that there are a lot of hidden assumptions that are made in this analysis. I’m an Economist so I guess I get off on this kind of thing…