Finance in a Global Perspective

Mid-Term Exam
July 13, 2023 (Fenn)

Name (Print): Nuti Jitendra Patel

Student Number: 110109655

Exam mark: ____________ out of 50. There are 12 pages to the exam.

Answer the questions in this booklet. Use Word and the space provided below to
answer. It is quality not quantity. Alternatively, hand write and scan your answers
to the emails below. Make sure you keep a copy of the sent email answers and
ensure it is sent properly, (time stamped).

Send by email to [email protected] and [email protected]. Note: send to

both emails. We will answer no questions during the exam. Indicate your
assumptions, if necessary.

Return by 1:45 pm on July 13th.

Format of the exam.

Part 1 – select three (3) out of 5 questions only.
Parts 2 and 3 are mandatory to answer.

Part 1 – Select three (3) out of the following 5 questions. (10 marks each)

1. A well-established Canadian company is considering foreign transactions. It has a strong

supply base in Canada under which it closely monitors its brand image. It is a market and
brand leader in Canada. Shareholders are concerned that the growth of the company may
slow in Canada if marketing quality decreases. The required return for the company is 10%.
The US has exceptional marketing agencies that can support the Canadian or US markets.
The Canadian dollar has strengthened against the US dollar recently (US$1.00 moved from
C$1.30 to C$1.20). The CFO and CEO understand that going international has many
complications compared to domestic operations and many different modes of entry. They
have also heard the term “Seekers” used recently by consultants advising companies on
how to go global when trying to fit this into the company’s strategic plans. Given this
scenario, answer the following questions relating the answers to the case situation:
a. What type of Seeker do you feel best fits this company and why? (Only one Seeker!)
b. What is a strategic consequence of the strengthening Canadian dollar?
The company allocated US$50 million in a new budget. How much would it cost the company
to buy this advertising, before and after, the exchange rate change in Canadian dollars.
c. If the company’s estimated earnings are C$6.0 million related to implementing this
advertising budget, what is the return on investment? Good or bad for the company?
d. Which element of value creation and governance is crucial to success?
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July 13, 2023 (Fenn)

Answers:

a.

b.

c.

d.

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Mid-Term Exam
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2. A Canadian parent company (P Co.) is establishing a wholly owned sales company in

Mexico (S Co.). It will continue to manufacture and assemble products in Canada and do
research, design, pilots and purchasing in Canada, as well. S Co. will sell to the Mexican
retail market through an independent company (I Co.). The expected return is 25% for
subsidiaries. The product to be sold has the following attributes.

Costs to P Co. $25,000

Costs to S Co. $22,000
Costs to I Co. $23,000
All Costs exclude interest expense here
Price to retail customers $100,000
Activities performed by P Co. 30%
Activities performed by S Co. 30%
Activities performed by I Co. 40%

P Co. pays out 30% of its consolidated net income to its shareholders as dividends. The tax
rate on its consolidated net income is 30% and S Co. pays 30% tax on its EBIT. The
transfer price from P Co. to S Co. will be collected every 30-days. Given this scenario,
answer the following questions:
a. What is the EBIT of P Co., S Co. and consolidated P Co. respectively?
b. What is the net income of P. Co. consolidated. P Co. consolidated has $2,000
of interest expense. S Co. has no interest expense. How much of a dividend is
P Co. expected to pay out to its shareholders?
c. If S Co. pays a 30% dividend to P Co. (ignoring withholding taxes), does P Co.
have enough cash from S Co. sources to pay out its dividend in b. Show why
or why not.
d. If P Co. capitalized S Co. with common stock of $32,500, what is the return on
equity for S Co in Canadian dollars after the dividend in c. Good or bad for the
company?

Answers
a. Total Price to Retail Customers $100,000 – Total Costs $70,000 = $30,000
P Co. = EBIT $9,000 = Revenue $30,000 * 30%

S Co. = EBIT $9,000 = Revenue $30,000 * 30%

I Co. = EBIT $12,000 = Revenue $30,000 * 40%

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Mid-Term Exam
July 13, 2023 (Fenn)

Consolidated P Co. = EBIT $18,000 = $9000 + $9000

b. Consolidated P Co. EBIT $18,000 - Interest expense $2000 = $16,000

Net Profit After Tax = $16,000 – {$16,000 * (1 – 0.30)} = $11,200

Expected Dividend = $11,200 * 30% = $3,360

c. EBIT $9,000 * (1 – 0.30) = EAT $6,300

Dividend = $6,300 * 30% = $1,890

The dividend of company S is too low to cover $3,360 but there is also cash from the
intercompany sales receivable from S Co. that could be collected to help pay dividends
at the P Co. level.

d. Actual return = (Net Income $ 6,300 – Dividend $1,890) / Common Stock $32,500

= 13.57%

It is bad for the company as return is low.

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3. Given the following information, complete the C$ This Yr column and answer the questions
below. The company uses the PCT method. This subsidiary company was set up in the
United States (US) last year on December 31st when the US$ = C$1.00. You are converting
into the parent company’s Canadian dollar currency.

Assumptions:

 Year-end exchange rate US$ = C$1.30

 Average exchange rate US$ = C$1.25
 Retained earnings opening exchange rate US$ = C$1.00, if any
 Historical rate on fixed assets US$ = C$1.00
 Common stock US$ = C$1.00

Questions:

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a. Fill out chart (fill in the blanks)

Balance Sheet: US$ this Conversion C$ This Yr C$ Last Yr
YR rate

Cash 3000 C$ 1.30 C$ 3,900 -

Receivables 3000 C$ 1.30 C$ 3,900 3000
Inventory 1000 C$ 1.30 C$ 1,300 1000
Fixed Assets 14000 C$ 1.30 C$18,200 14000
Debt (9000) C$ 1.30 (C$ 11,700) (9000)
Common Stock (9000) (C$ 9,000) (9000)
Retained Earnings, prior - C$ 1.0 - -
Net Income (3000) (C$ 3,750) N/A
Translation (C$ 2,850) N/A

US$ This Conversion C$ This YR

Income Statement: YR rate
N/A
Sales 20000 C$ 1.25 C$ 25,000
Costs of Sales (10000) C$ 1.25 (C$ 12,500)
Depreciation (5000) C$ 1.25 (C$ 6,250)
Other Fixed Costs (1000) C$ 1.25 (C$ 1,250)
Taxes (1000) C$ 1.25 (C$ 1,250)
Net Income 3000 C$ 3,750

b. What is an advantage of the PCT method and internal rate method?

c. What is necessary for the parent company to apply the PCT method?
d. What is the return on equity for the Canadian parent?

Answers:

a. Fill out the blanks in the chart above

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Mid-Term Exam
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b. The advantage of PCT method is that companies can determine its present valuation
and, could sell off the subsidiary if it finds necessary. Gains can be shown by the
companies using both the PCT and internal rate methods since any gains or losses
would not directly influence the income statement due to changes in currency exchange
rates.

c. The parent firm must decide which of the following conditions must be met in order to use
the PCT method:
It is obligatory for the firms to be eligible for this strategy, the subsidiary operation must
not be wholly dependent on the parent firm and be self-sustaining.
It is optional that in the foreseeable future, the parent firm might sell the business's
assets.

d. Return on Equity: C$ 3,750 / C$ 9,000 = 41.67%

4. The following foreign exchange spot rates have been accumulated by a bank market maker.

US$0.7692=C$1

a. Show, through calculations, whether the exchange rates above are in

equilibrium.
b. Calculate the arbitrage profit or loss if the C$:US$ spot exchange rate changes
to C$1.3200 = US$1 and US$0.7576 = C$1.00 because of the balance of
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Mid-Term Exam
July 13, 2023 (Fenn)

payments, while all other exchange rates stay the same. Specify the
transactions that will take place.
c. From a Canadian perspective, is the Canadian quotation a “direct” or “Indirect”
quote. (i.e., C$1.30 = US$1.00)
d. In b. has the Canadian dollar strengthened of weakened and what is a possible
reason via the balance of payments.

Answers:
a.

b.

c.

d.
5. Currently, the US$1.00 = C$1.30. The US and Canadian nominal interest rates are
expected to be 6% and 4% respectively for the next year. The forward price is:

Answers:

a.1 US $ Forward price = 1/1.30 *{ 1 + (0.06 – 0.04)}^1

= 0.7846 $ US

a.2 Canadian $ Forward price = 1/0.7846 = 1.2745 $ C

Prove the exchange rate is arbitrage free?

Canadian invests C$1,000 in the US for one year and enters into a forward contract to
bring the money back at that time to Canada.

b.1 Invest initially in the US: Valueus

C $ 1000 * 0.7692 = $769.2

US $ 769.2 * 1.06 = $815.352
US $ 815.352 * 1.2745 = $1,039.17
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Mid-Term Exam
July 13, 2023 (Fenn)

b.2 Invest in Canada = C $ 1000 * 1.04 = $1,040

So, the rate here is arbitrage free. The equilibrium rate is $ 1.2745. We can conclude that
it is a good forward rate.

c. What is the “real” interest rate if inflation is 3% in the US and 1% in Canada.

In Canada:

Real interest rate = Canadian nominal interest rate - Canadian inflation rate

= 0.04 – 0.01

= 0.03 or 3%

In USA:

Real interest rate = US nominal interest rate – US inflation rate

= 0.06 – 0.03

= 0.03 or 3%

d. What is the nominal interest rate in Canada and the US, if inflation increases to
5% and 4% respectively.

In Canada:

Nominal interest rate = Real interest rate + Canadian inflation rate

= 0.03 + 0.05

= 0.08 or 8%

In USA:

Nominal interest rate = Real interest rate + US inflation rate

= 0.03 + 0.04

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= 0.07 or 7%

Part 2 - Multiple Choice Questions (10 marks) Circle the most likely answer

1. The multinational financial system does NOT enable companies to (ignore hedging in your answer)

a) avoid currency controls

b) reduce taxes
c) access lower cost financing sources
d) avoid exchange rate risk

2. Apex Inc., a maker of consumer products, has certain organizational skills. These skills include
knowing how best to service a market through new-product development and adaptation, quality
control, advertising, distribution, and after-sales service. Based on these skills, Apex's best avenue to
international expansion would appear to be

a) exporting
b) licensing a local firm to produce its goods
c) local production
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Mid-Term Exam
July 13, 2023 (Fenn)

d) joint venturing with a local firm

3. The choice of whether to sell abroad by exporting, licensing foreign producers, or manufacturing
abroad depends on all of the following EXCEPT

a) the nature of foreign government regulations

b) whether the firm's competitive advantage can be transferred abroad
c) whether customers are looking for some signals as to the firm's commitment to the local market
d) the currency of the parent market

4. Corporate international diversification will prove most beneficial to shareholders

a) when operating in a number of countries whose economic cycles are not perfectly in phase
b) where a competitive advantage is not appreciated
c) where dividends are paid in foreign currencies
d) where the local government is friendly

5. Translation into a parent’s consolidated financial statements using the PCT method will be used
where the subsidiary is ______________ and return on sales will be ____________ as the internal
management method.

a) integrated, different
b) self- sustained, different
c) integrated, the same
d) self-sustain, the same

6. Suppose parent A sells goods worth $1 million monthly to subsidiary B. The tax rate for A is 30% and
the tax rate for B is 40%. If A increases the selling price to $1.5 million monthly, the net income of the
consolidated company will

a) Decrease
b) Increase
c) Stay the same

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July 13, 2023 (Fenn)

d) Be neutralized

7. The goals of a good monetary system include all below EXCEPT

a) promote capital movements

b) promote reasonable stability of the currency
c) guarantee foreign exchange profits
d) create a recognized medium of payments

8. Usually the first step that a firm takes to penetrate a new unknown foreign market is

a) make an alliance with a firm already in the new market

b) hire a firm already in that market to advise on entering the new market and the mode of entry
c) sell their products in the new market by producing products in the new market.
d) sell existing products in the market and then create new products for the market.

9. Trade account deficits can cause (best answer) without government interaction

a) increased exports
b) less financing needs
c) currency depreciation
d) less domestic production

10. How can the way a firm arranges its affairs limit its foreign currency risk?

a) Offset foreign currency payables and receivables in the same currency

b) Stop sales in foreign countries
c) Use the PCT translation method
d) Require suppliers to absorb the foreign currency risk

Part 3 – True and False (10 marks) – Indicate either True or False with X

# Question True False

1 Globalization has reduced the integration of suppliers, X
producers and consumers worldwide.
2 A profitable business depends on a sustainable X
competitive advantage and strategy by balancing
customer benefit versus price.
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Mid-Term Exam
July 13, 2023 (Fenn)

3 The raw material seeker will export to take advantage X

of cost savings in a foreign location.
4 Purchasing power parity assumes changes in the real X
interest rate will result in a change in the exchange
rates of the respective developed countries.
5 A market seeker is looking to improve its market X
potential by increasing sales in a foreign location.
6 The PCT translation method reports translation X
expense or income in net profits. Foreign managers
like this because it gives them control.
7 Robust economic activity (causing demand or X
inflation), high interest rates and trade deficits /
surpluses affect currency pricing and the type of
intervention needed by Central Banks around the
world.
8 A sales subsidiary helps with customer service and X
communication.
9 The balance of payments equilibrium is always X
balanced by changes in foreign investment funding.
10 The pegging system of setting exchange rates was X
successful globally because countries could
manipulate their exchange rates for their advantage in
trade.

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