Cost Management: A Strategic Emphasis 5th Edition by David Stout, Edward Blocher, Gary Cokins

Exercise 1

Foreign Currency Translation, Transfer Pricing, and Profits

Nike is probably correct that U.S. prices for its products and those of its competitors will not change much. The reason is that the cost elements of its products from Southeast Asia affected by the falling local currencies, primarily labor costs, represent only a modest portion of the total product cost. Most of the cost of these manufactured products is for materials, which are imported from the United States and elsewhere outside Southeast Asia. Thus, the effect of the falling Southeast Asian currencies on total product cost is likely to be small; Nike estimates it to be 10 percent or less although some currencies have fallen to less than half of their previous value to the dollar.

Moreover, Southeast Asian manufacturers find that they have increased financing costs and sometimes reduced financing availability when the local currency falls and the raw materials from the United States and elsewhere become more expensive. For some of these manufacturers, the total operating and financing cost (in U.S. dollars) might even increase.

From a transfer-pricing perspective, the dramatic change in currency value presents real problems in performance evaluation. Should the local manufacturing unit be responsible for costs in U.S. currency or in terms of the local currency? Are the currency fluctuations controllable by the local managers? The answers to these questions are difficult and complex, but many companies expect their local managers to take steps to mitigate the negative effects of currency fluctuations by buying or selling options or other financial instruments, for example.

Source: Based on Jonathan Moore and Moon Ihlwan, “Cheaper Exports? Not So Fast,” BusinessWeek, February 2, 1998, pp. 48–49.

Step 1 of 2

Exchange rate is the rate at which the currencies of two countries are exchanged in making or receiving payments for imports or exports made. Import is buying of good from foreign country and export is sale of domestic good to foreign country.