The US multinational enterprise (MNE) that we discuss in the paper is Ford Inc. The company is headquartered in Dearborn, Michigan and company has operations in six continents (Ford, 2009). It is a leader is the global automotive industry as a manufacturer and distributor of automobiles. The company has almost 90 plants worldwide.
As the company has its operations worldwide, the company follows of reporting its revenue in the domestic currency (i.e. US Dollars) as reported in its Annual Report (Ford, 2008). Ford has posts in its annual reports revenue earned from its operations in Europe, Asia Pacific and Africa, North America, and South America in the same currency. This is done in order to dissipate foreign currency risk; given that, US dollar is one of the more stable currencies in the world. Even though revenue posted by the company is in dollar, the prices charged by the company in foreign lands are the domestic currency of the land. For instance, they charge for their car in China in Yen and in Rupees in India.
Now let us consider the country’s operation sin Asia Pacific and Africa. The operating highlights presented in the Ford’s annual report for 2008 showed that the sales figure of the company in 2008 from the region was 464 thousand units (Ford, 2008). It forms 8.3 percent of the total sales volume of the company. However, according to the pre-tax operating results for second quarter of 2009 showed that the Asia Pacific operations faced an operating loss of $25 million (Ford, 2009).
The Asia Pacific market, especially China has shown a 39 percent rise in total sales in second quarter of 2009. In the Asia Pacific market, the company’s market share has increased by one-tenth of a market point. However, the revenue earned in the region has declined since 2008 in second quarter of 2009 from $1.7 billion to $1.2 billion. Pre-tax profit in the region for the period has gone down from $50 million in profits to $25 million loss. Therefore, the study shows that the sales and revenue earned in the region has dipped from 2008 in 2009.
The share of profit that the Asia pacific region has to the company’s profitability is 2.4 percent in second quarter of 2009. In the third quarter of 2009, the company posted a pre-tax operating profit of $27 million (Ford, 2009). This is a 575 percent increase in operating profit from third quarter 2009. Therefore, the share of profit of Ford from its Asia Pacific and African earnings is increasing constantly as Ford concentrates more on the emerging Asian markets like China.
The foreign currency risks are higher for the company as it has its operations in different parts of the globe. The company uses derivative instruments to hedge the risk of economic exposure with respect to the revenues, costs, assets, liabilities, etc. forecasted priory. The hedging done by the company mainly aims at reducing the risk of foreign exchange fluctuations.
The instruments that are usually used are forwards, options, etc. here the foreign exchange instruments like forward allow the company to lock-in of a future exchange rate which provides dissipates risks against adverse movement of the currency which is mostly used. The technique, which is posted by Ford in its 2008 Annual Report, is as follows:
“The net fair value of foreign exchange forward and option contracts of December 31 2008 was an asset of $249 compared to $632 million as of December 31, 2007. The potential decrease in fair value of foreign exchange forward and option contracts, assuming a 10% adverse change in the underlying currency exchange rates would be approximately $600 million in 31, December 2008 and was $2 billion as of December 31, 2007.” (Ford, 2008, p. 59)
This shows that if there is an increase is an adverse movement of the foreign exchange rate then the risk will be dissipated due to the instrument of hedging used by the company.
Now if there is an increase in the dollar exchange rate, implying that the value of dollar increases vis-à-vis another currency buying raw materials, say from Mexico will become cheaper. This will bring down the cost of production for the company as the cost of Acquiring raw materials becomes cheaper. The reduction in cost will affect the profitability of the company positively increasing the profits earned by the company. Now if there is a decrease in the exchange rate and dollar becomes cheaper vis-à-vis other currencies then the cost of buying raw material from the foreign country will become dearer as the cost of production will be increased by the rise in cost of raw materials. This will reduce the profit of the company. For example, if we consider the case of Ford buying a plant in Mexico for $100 million which is expected to become $1 billion in one year. Now one year from now, the exchange rate for peso to dollar become 9 peso equals $1 instead of 10 peso equal to $1 previous year. This would make the cost of the plant to be $111 million with an $11 million cost which was unanticipated by the company. This the foreign exchange risk that the company runs due to its operations spread globally. Now if peso moved to the other direction relative to dollar, the Ford would have gained from the transaction.
Reference
Ford. (2009). About Ford.
Ford. (2008). Annual Report. Web.
Ford. Ford Posts Q3 2009 Net Income of $1 Billion; Cash Flow Turns Positive; North America Profitable. Web.
Ford. (2009). Second Quarter Earnings Review. Web.