International Financial Management - Essay Example

International Financial Management Part Historical Background of India and China China and India have had a great record of economic growth and development since the ‘80s and 90’s respectively. This has made these two economies be the subject of many studies. The highly populated countries began their development processes with humble beginnings. Using the Gross Domestic Product as an indicator, China’s economic size was the same as that of Japan and Korea in the mid ‘60s and 80’s respectively.

On the other hand, India’s economic size was the same as that of Japan and Korea in the mid ‘50s and 70’s respectively (International Financial Statistics, 2011). Global trade, economic growth and poverty reduction have been impacted by the success of these two economies because of their population sizes. China and India account for two-fifth of the world population. China’s economy is the 3rd largest importer and exporter. This has given it a say in global price levels especially of commodities and manufactured goods.

There have however been issues regarding the sustainability of these two economic giants. This should be addressed in determining which of these two countries is best suited for business investments (Kolodko, 2002). Analysis of Prospects of the Firm The revenue per a unit sale of a global positioning system is $2000. This is the global trade price. It therefore does not depend on where the production is taking place. The cost of goods sold in the US is 55% of sales amounting to $1100 per a unit of the GPS.

Hardware costs accounts for 30% which is equivalent to $330 while software costs accounts for 70% equivalent to $770. There gross profit of per a unit of the output is equal to the difference between $2000 and $1100 which is $900. China’s Case If the firm decides to invest in China, it will enjoy a 45% reduction in software costs and a 7% reduction in hardware electronics manufacturing costs. This implies that costs of hardware will reduce from $330 to approximately $307 while those of software will reduce from $770 to approximately $423.

The new gross profit per unit sale of the GPS will be $2000 – ($307 + $423) = $1270. In China, The level of gross profit per a unit sale of the output is greater compare to the same for production in the US by $1270 - $900 = $370. India’s Case If the firm settles to invest in India, it will enjoy a 32% reduction in software costs. Since it is less likely that India has the resources required for hardware manufacturing, the firm is more likely to outsource hardware from China. Assuming that transportation costs are zero, the firm will save 7% of hardware electronics manufacturing costs just as the case of China .

This implies that costs of hardware will reduce from $330 to approximately $307 while those of software will reduce from $770 to approximately $524. The new gross profit per unit sale of the GPS will be $2000 – ($307 + $524) = $1169. The level of gross profit per a unit sale of the output is greater for India compared to the US by $1169 - $900 = $269. Comparison of Gross profit between China and India The assumption of zero costs of transportations is used to make the analysis simpler. Regardless of whether we have zero or positive transportation costs, production of the GPS using India’s software production resources leads to lower gross profit as calculated above.

From the profitability perspective, while holding other factors constant, it is more advisable for the firm to invest the $300 million capital in China than either in India or US. The factors held constant are all other costs in the balance sheet except the hardware and software costs evaluated above. The level of taxes in the two countries in also held constant between the three countries. Ethics in Foreign Vs. Domestic Investment There are two views regarding ethics in foreign versus domestic investments namely; Conservative View and Liberal View.

Conservative View Proponents of this view can be said to be opposing change related to globalization. This is because they prefer domestic investments even in case where it is more economical to producer outside the boundaries of the local economy. They argue that is more ethical to invest in the domestic economy due to the various spill-over effects associated to increased domestic investments. These include higher levels of employment, higher incomes to those employed due to domestic investments, higher taxes and more distributive justice (Johnson, 2004).

Liberal View Liberalists argue that the main purpose of business investments is profitability. Therefore, a firm should invest in any part of the world where is able to maximize its profits for its owners. Further, proposers of this view argue that regardless of where the investments are made, shareholders of the firm (who are more likely to be US citizens) will contribute to higher domestic consumption than they would have if they invested in the domestic market (Johnson, 2004). This would ultimately lead to higher economic growth for US at large than if the investment would be made in the US.

Reference Johnson, R. (2004). ‘Economic Policy Implications of World Demographic Change’, Economic Review, First Quarter, Federal Reserve Bank of Kansas City. Print. International Financial Statistics, January Issue, IMF, East Asia Quarterly Brief, World Bank, December 31, 2011. Print. Kolodko, G. (2002). ‘Globalization and Catch-up in Emerging Market Economies’, WIDER Discussion Paper 2002/51, UNU-WIDER: Helsinki. Print. Part 3 Historical method Income statement and balance sheet items are translated at the historical rate for each item.

The historical rate was current rate when the transaction occurred. Income statement items should be translated at the rate of exchange prevailing at the date the income and expenses are recognized. Items of equity are similarly translated at appropriate historical exchange rates (Pratt, 2010). Closing-rate method All income statement items and balance sheet are translated at the rate of exchange present on the date of reporting. This is similar to the historical method where monetary items are translated at the exchange rate current on the reporting date.

Even so, foreign operation’s financial statements’ items are translated by the same exchange rate. This results in no translation loss or gain (Loren, John & Jefferson, 2009). Temporal Method This method differs from the two above in that, income statement items and items documented in the balance sheet in their historical cost are translated at the relevant historical exchange rate. Liabilities and Assets that are expressed at net market value or current replacement cost are translated at the rate of exchange rate present on the date of reporting date.

There is a translation gain or loss unlike the closing rate method (Clyde, Roman, Katherine & Jennifer 2009). Current-rate method Items of the Balance sheet are translated at the rate of exchange present on the date of reporting, while items of the income statement are translated at the relevant historical rate of exchange. This differs from the closing-date method where items of the income statement are translated at rate of exchange current on the date of reporting. Translation losses or gains are not acknowledged in the income statement.

However, they are accumulated in statement of financial position as a foreign currency translation reserve (Loren, John & Jefferson, 2009). FASB-52 allows two translation methods - the temporal method or the current-rate method . A two-step process used in the FASB-52: 1. The affiliate’s functional currency must be determined. The reporting currency of the parent company must be chosen as the foreign affiliates functional currency whenever the affiliate functions in a highly inflationary market or economy.

A highly inflationary market undergoes cumulative inflation of almost 100 percent or above over a period of 3 years. 2. Involves the actualization of costs reported in the local currency into the functional currency. The measurement act is intended to give out to the same result just as if the books of the affiliate had been kept in the functional currency. FASB 52 instructs that historic rates of exchange should be used (Pratt, 2010). The translation practices used in Japan and Germany are well defined.

However, many German companies employ a current rate method which is modified. Therefore, many firms employ historic rates for translation of fixed assets. Most Japanese companies use the temporal method which is in a modified version. This version translates long-term monetary liabilities and assets at their respective historic rates (Clyde, Roman, Katherine & Jennifer 2009). The United States should change its translation method to be similar to that of the European Union. In the wake of the current high levels of globalization, firm in the global market should stream line their accounting methods for comparability.

This will aid in the promotion of sound judgment by investors and lender in the global capital and financial market facilitated by use of comparable information. Reference Clyde, P., Roman L., Katherine, S & Jennifer, F. (2009). Financial Accounting: An Introduction to Concepts, Methods, and Uses. New York: Cengage Learning. Print. Loren, A., John, D. & Jefferson, P. (2009). Intermediate Accounting. New York: Cengage Learning. Print. Pratt, J. (2010). Financial Accounting in an Economic Context.

Washington: John Wiley & Sons. Print.