None of our client companies operate in a foreign country. They don’t sell into a foreign market. Nor do they manufacture in a foreign market. So we will use a hypothetical manufacturing company, Daewoo, for the assignment.
Daewoo is an American automobile manufacturing company that makes cars in the U.S. and sells in the U.K. market. Assume that a majority of its revenue comes from the U.K. market. Read the attached article, and answer the following questions.
Monetary Policy: -Did the Bank of England increase or decrease interest rates? Bank of England increased their interest rates to 2.25%, the highest level since 2008. -What is the purpose of the policy move, and what is its risk? The policy move is to cap energy costs and cut taxes. The purpose of doing this is to lessen the pain of the higher cost of living. Additionally, by doing this they expect inflation to peak sooner and at a much lower rate. However, the risk of this policy move is the potential to raise longer-term inflationary pressures. One of these might be an increase in the amount of bonds that the government has to sell to raise money to subsidize energy bills. -How would it impact Daewoo’s profits? An increase in interest rates means that there will be a decrease in asset prices. This means that Daewoo’s assets will decrease in value and also less able to access credit. There will also be an increase in cost of financing, which means that consumers will reconsider large purchases like a new car. -What should the company do? Daewoo should monitor the economy very carefully, because if England go into a recession, the costs will go up and the demand of new cars and expensive parts will decline. The company might want to consider increasing their profits from the US market and not be too dependent on their profits from the UK market. Daewoo should also communicate with their customers, and make sure that you adapt according to their demands and needs. One of the most important things is to plan ahead. They must be prepared for demand fluctuations, cost increases and a period of economic change.
Foreign Exchange Risk: -Is the British Pound increasing or decreasing in value against the U.S. Dollar? The British pound is decreasing in value against the US Dollar, and it is currently at $1.12, which is the lowest the pound has been since 1985. -What would that mean for Daewoo’s profits? This means that Daewoo’s profits will decrease. Daewoo’s revenue in the UK can be converted to Dollars, which means that this is the worst time to do that. The US Dollar is almost equal to the British Pound, which is the closest the Dollar has been to the Pound in almost 40 years. Easily said, for every British Pound that Daewoo earns, they earn less dollars now that the Pound is decreasing in value. -What should the company do? The company should not convert their earnings in the UK to dollars, but they should also monitor the currency exchange rates because the British Pound might get even worse, which means that Daewoo will decrease their profits even more. Daewoo should keep selling cars, and maybe increase their prices a little bit, because they lose money for every car they sell compared to a couple years ago.
What if, instead, Daewoo made cars in the U.K. to sell in the U.S. market? How would your answer above change? Elaborate.
If Daewoo made cars in the UK which they sold in the US market, most of the answers would be the opposite. For example, Daewoo’s profits would increase because the Dollar is stronger compared to the Pound than it was before. This means that if they sell a car for $50,000, this will be worth more in British Pounds than it was a couple of years ago. However, the manufacturing costs would be a lot more expensive in the UK right now. This might mean that they would have to increase their prices. This could lead to a decrease in sales, or if they don’t increase their prices, their profits will decrease because their expenses have increased. If Daewoo made their cars in the UK but got most of their profits from the US market, this would be the perfect time to connect with their US customers to make sure that the cars they produce are aligned with their customers needs. By doing this they can increase their prices a little bit and still not have a decrease in sales, which means an even bigger increase in profits. All of their profits should also be converted back to British Pounds because for every dollar they sell for, they get 0.86 British Pounds, compared to 0.73 a year ago.