Procter and Gamble as a Multinational Company - Research Paper Example

Multinational Company Abstract Procter & Gamble just like any other multinational companies would have to benefit from its foreign operation in attaining its overall profitability in order to justify it said foreign operations economically. However, its foreign operations exposes the company to exchange currency risks. The company however is not left defenseless, as there are ways to hedge against such risks include interest rates swaps, forward contracts and currency swaps as applied. This could mean therefore that derivatives to hedge against exchange risks are necessary part of multinational operations for more profitable operations and stable financial condition. 1. Introduction This paper has selected Procter and Gamble as the US multinational company for purposes of discussing how the firm prices its revenues cost in terms of currency denominations. This paper will consider how two of its multiple foreign operations contribute to the parent firm’s profits and what means does the company management use to hedge against exchange rate risk. Given this information, this paper will assess what would be the effect of increases/decreases in the dollar’s exchange value on the firm’s profitability. 2.1 How Procter & Gamble prices its revenues cost in terms of currency denominations? The company has reported its revenues and costs in terms of US dollars in its consolidated financial statements from its having multiple foreign operations, which may have currencies other the US dollar (Procter & Gamble, 2010). This means that that as a single-economic- entity company, it prices its revenues and cost in terms of US dollars in the final report and analysis. Its foreign subsidiaries however outside the US use local currencies generally as functional currency in their respective financial statements. At the consolidation date, adjustments are made to translate the financial statements of foreign operations under local currencies into the US dollars and adjustments are recorded in other comprehensive income (or “OCI”). It reported that currency translation adjustment in accumulated OCI were a loss at June 30, 2010 and a gain at June 30, 2009. For its subsidiaries operating in highly inflationary economies, the company uses the U.S. dollar as the functional currency. OCI does not affect earnings but its remeasurements adjustments for financial statements in cases of highly inflationary economies get reflected in the company’s income statement (Procter & Gamble, 2010). 2.2 How two of its multiple foreign operations contribute to the parent firm’s profits? Its foreign operations contribute to the firm’s profits in terms of higher revenues. Two of its foreign operations come from China and India. More revenues generally mean more profit as it expected that goods or services be sold above cost or at a mark-up. One of its business segments in on health and well being under which the claims to a favorable operation in China with its launch Crest Pro-Health. Since the product is designed to address common health issues that dentist check most, millions consumers in China are said to be tech-savvy as they rely on social media for advise on making purchase decisions of the product. Information from bloggers for just few weeks caused the company to estimate about more than a hundred million potential Crest customers (Procter & Gamble, 2010). The company claims to have modified its regular detergent named Tide for India market with due consideration of the extremely limited budgets of consumers in India (Procter & Gamble, 2010). The company was able therefore to lower the price but in exchange, it would mean also higher revenues and lower cost than regular products and still more profitability for the company’s total or consolidate profitability from its foreign operations. By lowering the price for Indian market, it has about 600,000 outlets in India, which definitely increase revenues and profitability for the company (Procter & Gamble, 2010). 2.3 What means does the company management use to hedge against exchange rate risk? The company uses interest rate swap to eventually hedge against exchange rate risk of the company’s US dollar investments in foreign operations (Procter & Gamble, 2010). This is on the premise that certain interest rate swaps are denominated in foreign currencies so that the company can hedge exposure to interest movement on the underlying debt obligations of its foreign subsidiaries, which generally adopt local currencies for their functional currencies (Procter & Gamble, 2010). Hedging against interest movement therefore is meant to hedge exchange rate risk (Bodie, Kane and Marcus, 2007; Brigham and Houston, 2002). The firm’s foreign investments get protected therefore fluctuations in the interest rates of underlying obligations which are necessary consequences of foreign investments. The company also uses forward contracts and currency swaps (Whaley, 2006)) to hedge against risks in its currency rate exposure on financial instruments. The company explains that since it manufactures and sells products and finance operations in a number of countries throughout the world, it is exposed to the impact on revenue and expenses volatility in currency exchange rates (Procter & Gamble, 2010). Thus, its currency hedging activities is aimed primarily for risk reduction to avoid from being adversely affected by short-term changes in exchange rates so as to affect financial condition. 2.4 What would be the effect of increases/decreases in the dollar’s exchange value on the firm’s profitability? The US dollar may either appreciate or depreciate in relation with foreign currencies of countries where the firm operates. Renminbi or RMB, China’s official currency and Indian Rupee, India’s official currency may either appreciate or depreciate in relation to the US dollar. If the dollar appreciates in relation to the foreign currency, this would translate into making the latter to depreciate. Since eventually the foreign currency would be eventually be translated into US dollars, it is in the interest of the firm to protect the value of foreign currency from large volatilities that may materially affect its profitability or financial position. If the US dollar appreciates, local currencies in India and China depreciate. This could mean decreased purchasing power for people in China and India and therefore less demand for Procter & Gamble’s product in said countries. The opposite should also be true that if the U.S. dollar depreciates in relation to those two foreign currencies, the latter appreciate and therefore could mean more purchasing power and therefore increased demand for the company’s products. However, the effect of US dollar appreciation should not be seen only from the two foreign operations but on the overall effect on the company and this is the reason why the company would to hedge against risks volatilities in dollar’s exchange value. Although hedging aims to protect the company from fluctuations in dollar exchange value and not to increase profitability, still it could be deduced that such strategy will contribute to said profitability in the final analysis. 3. Conclusion This paper concludes that a multination company like Procter & Gamble faces more risks its currency exposure that one without foreign operations. By hedging however, said multinational company can reduce such risks, which may be deemed to have the effect of contributing to profitability. This makes a multinational economy to be more interested in the overall operation of a global economy, which entails different political and economic environments that could produce different kinds and degree of risks on dollar exchange value. References Bodie, Kane and Marcus (2007). Essentials of Investments, Sixth Edition, The McGraw−Hill Companies Brigham, E. and Houston, J. (2002). Fundamentals of Financial Management. Thomson South-Western Procter & Gamble (2010). 2010 Annual Report. Retrieved 26 September 2010 from http://www.pg.com/en_US/downloads/investors/annual_reports/2010/PG_2010_AnnualReport.pdf Whaley, R. (2006). Derivatives: markets, valuation, and risk management. 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