32. MNC Cash Flows and Exchange Rate Risk. Asheville Co.

has a subsidiary in Mexico that

develops software for its parent. It rents a large facility in Mexico and hires many people in
Mexico to work in the facility. Ashville Co. has no other international business. All operations
are presently funded by Ashevilles parent. All the software is sold to U.S. firms by
Ashevilles parent and is invoiced in U.S. dollars.
a. If the Mexican peso appreciates against the dollar, does this have a favorable effect, an
unfavorable effect, or no effect on Ashevilles value?
b. Asheville Co. plans to borrow funds to support its expansion in the U.S. The Mexican
interest rates are presently lower than U.S. interest rates, so Asheville obtains a loan
denominated in Mexican pesos in order to support its expansion in the U.S. Will the
borrowing of pesos increase, decrease, or have no effect on its exposure to exchange rate
risk? Briefly explain.
ANSWER:
a. Appreciation of the peso has an unfavorable effect because it results in higher dollar
expenses to Asheville Co.
b. Borrowing pesos will increase Asheville's exposure because it will increase the amount of
dollar cash outflows that are needed to cover expenses.