Problem 12-7 Foreign Currency Risk
During her first quarter review of the financial statements, Debra Bell, the CFO of HAL Computer Corporation, was distressed to notice the company’s transaction loss had been steadily increasing each month. HAL is a publicly held manufacturer of “PC clone” personal computers. Like most manufacturers of its kind, HAL does not manufacture domestically but utilizes lower cost offshore suppliers for components and subcontractors for assembly. As it is HAL’s policy to denominate foreign contracts in U.S. dollars whenever possible, the increase in transaction losses was particularly puzzling. Subsequent conversations with HAL’s controller, Tom Stewart, revealed all new contracts had been denominated in foreign currencies (primarily the South Korean won and Taiwanese dollar) in order to obtain more favorable purchase terms. Further, Mr. Stewart believed that the U.S. dollar would strengthen due to it being an election year. Since these contracts specify delivery and payment at various dates over the next 12 months, tremendous potential for exposure exists for the company if the dollar continues to decline against the major foreign currencies.
Required:
A. Mr. Stewart executed all new foreign contracts in foreign currencies in the belief it would help the company. (1) Do you think he was justified in his actions given the company policy? (2) On what basis did you decide if the controller was justified or not? (3) Was the loss a factor in your decision? Is this appropriate?
B. A substantial amount of foreign denominated contracts already exist for goods and services not yet received. (1) What actions may HAL take to minimize potential losses? (2) What are the advantages and disadvantages of these actions? (3) What implication does each of these scenarios have for financial statement disclosure?
C. Assume that you are Ms. Bell, and you are concerned about how the Board of Directors and the stockholders may react. Additionally, you are about to purchase a new home and are planning to sell some HAL stock for the down payment. (1) After carefully considering all of your options, what action do you decide to take? (2) Did concern over the Board, stockholders, or HAL’s stock price enter into your decision? Why or why not?
Click here for the solution: During her first quarter review of the financial statements, Debra Bell, the CFO of HAL Computer Corporation
