Question #109

Reading: Reading 10 Multinational Operations

PDF File: Reading 10 Multinational Operations.pdf

Page: 61

Status: Unattempted

Correct Answer: B

Part of Context Group: Q109-112 First in Group
Shared Context
- With respect to the British subsidiary, what method should be used to value its fixed assets, what is the appropriate exchange rate, and what is the translated value (USD)? A) Temporal method, historical rate, USD 547.7 million. B) Current method, historical rate, USD 547.7 million. C) Current method, current rate, USD 599.7 million. Neptune Corporation (Neptune) is a U.S. company located in Detroit, Michigan. Neptune supplies exhaust emission systems to manufacturers of passenger cars and light duty trucks. In January 2006, Neptune formed a wholly owned subsidiary, Continental Systems GmbH (Continental), to supply automotive manufacturers located throughout Europe. Continental is located in Stuttgart, Germany. Neptune reports its consolidated financial statements in U.S. dollars. The euro has been consistently appreciating against the dollar. Continental accounts for its inventory using the first-in, first-out (FIFO) cost flow assumption. Fixed assets consist of machinery, tools, and equipment. Contintential has net monetary assets.
Question
Assuming the current rate method is used to translate Continental's financial statements, as compared to the local currency ratios, which of the following statements about translated operating profit margin and long-term debt to equity ratios is correct?
Answer Choices:
A. Long-term debt-to-equity ratio will be higher
B. Operating profit margin will be higher
C. Neither ratio will change
Explanation
Under the current rate method, all revenues and all expenses are translated at the average rate. Consequently, the subtotals (gross profit, operating profit, and net profit) are translated at the average rate. Translating the numerator (operating profit) and the denominator (sales) at the same rate will have no impact on the ratio. Under the current rate method, all assets and all liabilities are translated at the current rate. In order for the balance sheet equation to balance, total shareholders' equity must also be translated at the current rate. Translating the numerator (long-term debt) and the denominator (shareholders' equity) at the same rate will have no impact on the ratio.
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