Answer feedback

Hi There,

I’m on the mock and came across Fondir Co, as part of the December 2022 paper.

I was wondering if this answer to part a could be reviewed please?

I came up with it by myself and its close to what I would have written in the exam.

Question
(a) Explain the exposure Fondir Co faces with respect to the falling sales revenue from Italy and suggest how this exposure could be managed. (6 marks)  

Answer:

Fondir faces economic risk when selling abroad and in particular the Eurzone where currency devaluation has made it more expensive for customers to purchase US products. Therefore,

companies operating in the same currency area face lower competition from international distributors, since their customers would prefer to buy from cheaper sources within the zone. This makes it attractive for businesses from the Eurozone to move into new markets within the same economic area.

If Fondir Co Invoices customers in their home currency that would remove their customer’s price sensitivity however would introduce transaction risk which would need to be managed by Fondir Co.

Increased pressure on the internal treasury department of Fondir Co to manage these risks could lead to higher costs through increased headcount to manage foreign reciepts and the transaction costs of using financial instruments such as options through the financial system.

Setting up a subsidiary within the Eurozone  which is able to source materials for production and sell to customers within the area would help elimate the economic risk of competiton from companies in Italy however the transaction risk of converting foriegn currency to the Fondir Co in the US as the parent company would remain. It would also be very costly to set up an autonomous subsidiary within the Eurozone to achieve this. Consideration would need to be focused on the benefit of increased foriegn sales versus the cost of setting up the subsidiary. Projected cash flows and the sources of finance would need to be assessed against the increased shareholder value through internation investment appraisal. 

Consideration must clearly be given to how either expanding the treasury department or setting up a subsidiary in the Eurozone would be financed,