Jensen Co. wants to establish a new subsidiary in Mexico that will sell computers to Mexican customers and remit earnings back to the U.S. parent. The value of this project will be favorably affected if the value of the peso ____ while it establishes the new subsidiary and ____ when the subsidiary starts operations
Social Studies · High School · Thu Feb 04 2021
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The value of this project for Jensen Co. will be favorably affected if the value of the peso "depreciates" while it establishes the new subsidiary and "appreciates" when the subsidiary starts operations.
When Jensen Co. is in the process of establishing the new subsidiary, it will likely need to convert U.S. dollars to Mexican pesos to cover the costs associated with setting up operations, such as purchasing or renting property, buying equipment, hiring staff, etc. If the peso depreciates against the U.S. dollar during this time, Jensen Co.’s dollars can be exchanged for more pesos, effectively reducing the cost of investment in local currency terms.
Once the subsidiary begins operations and starts earning revenue in pesos, the tables turn. Jensen Co. will prefer if the peso appreciates in value so that when the subsidiary remits its earnings back to the U.S., those pesos will get more dollars in exchange. An appreciating peso makes the profits earned in Mexico more valuable when they are converted back to U.S. dollars.
Extra: The concepts you're dealing with here are related to foreign exchange (forex) and the impact of currency fluctuations on international business operations.
When a currency depreciates, it means it has lost value relative to other currencies. So, if the Mexican peso depreciates compared to the U.S. dollar, each peso is worth fewer dollars than before. This situation is advantageous for a U.S. company when investing or buying in Mexico because their dollars have more purchasing power.
Conversely, when a currency appreciates, it gains value compared to other currencies. If the peso appreciates against the dollar, each peso can be exchanged for more dollars, which is beneficial when converting revenue earned in Mexico back to the parent company in the U.S.
Understanding the effects of exchange rates is crucial for businesses engaging in international trade or investment. Exchange rates can fluctuate due to various factors including economic policies, market speculation, political stability, interest rates, and trade balances. Companies may use hedging strategies with financial instruments like futures contracts, options, and forwards to mitigate the risks associated with exchange rate fluctuations. These topics are fundamental in corporate finance and international business studies.