ANALYTICAL APPLICATION 1

DFI Strategy ABC Co. has recognized numerous opportunities to expand in foreign countries and has assessed many foreign markets, including Brazil, Greece, Mexico, Portugal, Singapore, and Thailand. It has opened new stores in Europe, Asia, and Latin America. In each case, the firm was aware that it did not have sufficient understanding of the culture of each country that it had targeted. Consequently, it engaged in joint ventures with local partners who knew the preference of the local customers.

a. What comparative advantage does ABC have when establishing a store in a foreign country, relative to an independent variety store?

b. Why might the overall risk of ABC decrease or increase as a result of its recent global expansion?

c. ABC has been more cautious about entering China. Explain the potential obstacles associated with entering China.

PART II

Now suppose that ABC establishes a Chinese subsidiary that produces cell phones in China and sells them in Japan. This subsidiary pays its wages and its rent in Chinese yuan, which is stable against the dollar. The cell phones sold to Japan are denominated in Japanese yen. Assume that ABC expects that the Chinese yuan will remain stable against the dollar. The subsidiarys main goal is to generate profits for itself, and it reinvests those profits. It does not plan to remit any funds to the U.S. parent.

a. Assume that the Japanese yen strengthens against the U.S. dollar over time. How would this be expected to affect the profits earned by the Chinese subsidiary?

b. If ABC had established its subsidiary in Tokyo, Japan, instead of in China, would its subsidiarys profits be more exposed or less exposed to exchange rate risk?

c. Why do you think that ABC established the subsidiary in China instead of in Japan? Assume no major country risk barriers.

d. If the Chinese subsidiary needs to borrow money to finance its expansion and wants to reduce its exchange rate risk, should it borrow U.S. dollars, Chinese yuan, or Japanese yen?