International Financial Management - Neptune Plc - Assignment Example

? [INTERNATIONAL FINANCIAL MANAGEMENT] Introduction NeptunePlc is considering setting up manufacturing plants for water pumps in both the United States and South Africa, with a sole aim of profit maximization. This report analyses the possible effects that would accrue if the United States takes action to reduce its current account deficit, given that currently, all water pumps are manufactured in Europe. It also analyses the effects of devaluation of the Dollar. Pertaining to planned investments in South Africa by Neptune, this report outlines the possible threats of local firms’ resistance and how Neptune might respond to them. Finally, the report outlines the effects of currency variation of citing production abroad, if Neptune let sales in South Africa to be in Rand. Effects of the Possibility that the United States will take Action to reduce its Current Account Deficit on Neptune The current account deficit refers to a situation where the total imports into a country exceed the total exports (RupyaGyan, 2013). Reduction of the current account deficit means a reduction in the quantity and value of imports and an increase in the quantity and value of exports. The major aim of this move is to encourage and promote exports while protecting local firms of a country. However, it should be noted that a switch in expenditure from foreign to home goods reduces foreign income (Jones, 2003, p, 641). For instance, For instance, industrial countries sought to reduce their current account deficits by reducing oil imports or increasing their exports to other countries. As exports increase, current account deficit reduces (Siddaiah, 2010, p, 71). The possibility that the United States will take action to reduce its current account deficit will pose various effects on Neptune Plc. The speculated move of the United States will affect Neptune Plc both if either the company invests in the United States now or if continues to export water pumps to the United States. The possible future scenarios and how it might affect Neptune Plc have discussed in this report under two categories; exporting water pumps to the United States and investing in the United States by setting Neptune Plc’s manufacturing plants in the United States. Effects on Neptune Plc if it continues to Export Water Pumps to the United States If the United States’ government takes action to reduce its current account deficit, then the government’s main objective will be to reduce imports to its country and increase its exports. Most governments use the policy of reduction of the current account deficit to divert the expenditure of consumers away from imports and direct it towards home produced goods. Countries limit imports to reduce current account deficit (Neave, 2009, p, 301).This means that, as United States’ residents turn their attention to home produced water pumps, they will spend more in purchasing American manufactured water pumps and spends less in buying foreign manufactured water pumps that have been exported to the United States. Consequently, the demand for foreign manufactured water pumps, Neptune Plc’s water pumps being among the category is likely to reduce drastically. This is because Neptune Plc manufactures water pumps in Europe and exports to the United States of America. Consequently, this will lead to a decrease in profits because sales shall have decreased because of that scenario. The possible ways that the United States’ Government can use to reduce the current account deficit include demand-switching policies, foreign goods demand reducing policies and supply side policies (Gillespie, 201, p, 493). The use of tariff levies means that the United States’ Government will impose tax on imports. Definitely, imports’ prices will go up. This is because foreign companies that export goods to the United States, Neptune Plc being one of them, will raise prices of their water pumps to maintain their profit levels. As the prices of water pumps are raised, relative to United States’ home manufactured pumps, American consumers will purchase locally manufactured water pumps. This will have an adverse effect on the sales levels of Neptune Plc as they will decline significantly, leading to a decrease in profits. On the hand, if Neptune Plc decides to remain in the United States water pump market, it might decide to absorb the cost of tariff and take a cut in profits. This means that Neptune Plc will sell water pumps at the same price that it used to sell before the introduction of taxes on imports in the United States. Consequently, profit realised will be much lower, and will contravene Neptune Plc’s goal of profit maximization. Effects on Neptune Plc if it sets Manufacturing Plants of Water Pumps in the United States Setting manufacturing plants in the United States by Neptune Plc has various implications, as determined by a move of the United States ‘Government to reduce its current account deficit. As mentioned earlier, governments use the policy of current account deficit reduction to switch consumers’ expenditure away from imports and towards home produced goods. The same method of import controls such as tariffs and devaluation of exchange rates. This means that as the United States levy taxes on imports, prices of imports will be relatively higher compared to locally manufactured goods. The foreign firms that export goods to the United States have two choices, when such a move has been made. They can either absorb the cost of the tariff by accepting low profits. Alternatively, foreign firms can add up the cost of the tariff to the cost of production and distribution to the selling price and sell at higher prices. Consequently, if firms opt for the latter choice, their prices will be higher, in comparison with home produced goods. As a result American consumers will definitely purchase locally manufactured goods. Neptune Plc will benefit from the United States Government’s move to reduce its current account deficit, if it shall have established its water pump manufacturing plant in the United States when such a step is implemented. This is because Neptune Plc will be manufacturing and selling water pumps in the United States, by then. The company’s status in regards to import tariffs will be the same as that of United States’ local manufacturers of water pumps. This implies that Neptune Plc will not be affected by the tariff or tax on imports. Therefore, as other foreign manufactures of water pumps will be forced to cut on their profits, if they decide to absorb the import tax cost, Neptune will maximize its profits. As result, it will achieve its principal objective of maximizing profits in the United States’ water pump market. Also, as other foreign water pump manufacturers increase their selling prices in the United States because of the effect of the cost of the import tariff, Neptune will tap on the many consumers who will shift their purchases to locally manufactured water pumps. This means that the company will sell more of its water pumps in the United States’ water pump market and achieve its goal of profit maximization. The overall benefit of setting manufacturing plants in the United States is that the cost of production and distribution will be reduced, as the cost of import tariffs will be eliminated, thus maximizing profits. The Current and Possible Future Effects of Devaluation of the United States’ Dollar The current exchange rate is important in any business investment planning. It is vital to consider fluctuation in exchange rates before investing, especially in cases where firms are in stiff competition such as Neptune Plc and other firms that manufacture water pumps. Taking into account that Neptune Plc is in stiff competition in the US with local companies and a devaluation of the dollar could make Neptune Plc uncompetitive, it is important to evaluate the possible effects before investing. As the value of the Dollar goes down, demand for foreign goods goes down also (Blanchard & Milesi-Ferretti, 2009, p, 9). This means that home made goods will be relatively cheap and imports will be more expensive. As a result, United States consumers will switch their purchases from imports to home produced goods. On the other hand, consumers from other countries will stop buying their home produced goods and concentrate on US experts. A country may want to reduce its currency value to promote exports and discourage imports (Blanchard & Milesi-Ferretti, 2011, p, 5). It should also be noted that as the value of a country’s currency goes up in foreign exchange markets, foreign imports in that country become less costly while exports become more costly in foreign countries or markets (Allen, 2009, p, 105). However, when imports exceed exports it means a country’s currency is too strong and is likely to weaken in the future. Devaluation of the domestic currency leads to an increase in the price of foreign goods, relative to locally manufactured goods (Kandil, 2000, p, 4 and Owen, 2005, p, 3). This is because when the Dollar is devalued, local consumers or United States Consumers will be able to afford goods manufactured in the United States of America because it will be cheap for them. The reason for this is that it will be expensive for them to purchase foreign currency and then use it to buy foreign manufactured goods. For instance, if Neptune sells its water pumps in Euros, United States’ consumers will find it expensive to convert their dollars into Euros to be able to purchase the water pumps. Water pumps sold by Neptune Plc and other foreign water pump manufacturers will be more expensive, relative to United States manufactured water pumps. This means that the level of water pumps sales made by Neptune Plc will reduce drastically. This will reduce the amount of profit realised in the whole export business, in turn. Also, currency devaluation increases international competitiveness of local firms by diverting spending from foreign goods to locally manufactured goods. This means that United States consumers will spend more on United States manufactured goods than on foreign manufactured goods because of devaluation of the Dollar. This is because a current account deficit in US will mean that the demand for dollar to buy American exports will be lower than the US’s consumers demand for foreign currency to buy imports. Therefore, devaluation of currency makes the price of importing goods increase and quantity demanded for imports will be low. When a currency is devaluated, exports become cheap because there is an increase in export quantities (Pettinger, 2013, p, 1). The net effect of this move on Neptune Plc is that its water pumps will not be purchased as they could have been purchased if the Dollar was not devalued. Consequently, Neptune, Plc will make lower sales and realize minimal profits. Thus, Neptune may not realize its goal of profit maximization in the United States water pump market. On the other hand, if Neptune invests in the United States by setting water pump manufacturing plants in the United States, it might benefit from the devaluation of the Dollar. This is because devaluation of the dollar will lead to an increase in the overall price of foreign goods. Since Neptune Plc shall be manufacturing and marketing its water pumps within the United States, it will fall under the category of local manufacturers that manufacture and sell locally. Therefore, the effect of devaluation of the Dollar will be favourable for Neptune Plc. As United States consumers shift their attention to locally manufactured goods and ignore foreign goods, they will also purchase products manufactured by Neptune Plc at cheaper prices. This is because they will be buying water pumps from Neptune Plc and paying for their purchases in terms of Dollars. Therefore, they will not be required to convert their Dollars into another currency such as Euro before making their purchases, which is an Expensive process. Consequently, Neptune Plc will make significant sales and realise substantial revenues from sales, which will contribute to more profits. Thus, Neptune Plc’s goal of profit maximization in the United States water pump market shall have been realised. Investing in South Africa Investing in a foreign country is often characterised with resistance, especially the local manufacturers of the products that the investing company also manufactures and markets. For this case of Neptune Plc, it is feared that there might be resistance, in particular from a local manufacturer of water pumps in South Africa. Local resistance and outright rejection is common for companies that engage in foreign direct investments (Bandelj, 2011 and Cheng, Maitland, & Nicholas, 2009, p, 223). Also, on the other hand, local or host firms that look for foreign partners may fail to get one. The local water pump manufacturer may pose strong challenges to resist entry or investment by Neptune Plc in South Africa through various means. This means that even if Neptune Plc managed to force its way and invested in South Africa competition will be relatively high, and this might lead to losses or minimal profits. Therefore, a solution has to be formulated so that Neptune Plc investment in South Africa will be successful and profitable to enable the company realize its goal of profit maximization. One of the strategies that Neptune can use to counter resistance from the South African based water pump manufacturer is to engage in business mergers or acquisitions. Mergers with local firms create a sense of trust and cultural blending that reduces resistance in the local market (Ulijn, Duysters, & Meijer, 2010) p, 39. This means that Neptune Plc may capitalize on this opportunity and seek a merger with the South Africa-based local manufacturer of water pumps that is speculated to pose resistance or another South African company. Mergers also lead to the achievement of configuration of resource patterns between merging firms (Karenfort, 2011, p, 103). Also, the Neptune Plc may acquire one of the water pump manufacturing companies in South Africa. This will reduce the effect of resistance. However, the best option is to merger with the local manufacturer of water pumps that is likely to pose great resistance. Secondly, Neptune Plc can observe and analyse the actions of previous investors. It is not a must these previous investors have to be water pump manufacturers, but they can be foreign investors from a different sector that had a threat of resistance, but managed to invest in the South African market. Analysing the steps and actions that these companies took will provide a guideline on what Neptune Plc can do to counter or reduce resistance. The Effects of Currency Variation It is noted that most of the sales in Africa are in Rand, and sales to the United States in Euros. Compared to the United States where most of the costs would be incurred locally if production was moved over there, in South Africa, there would be a strong imported element from its production plant in Europe. Neptune Plc should consider the effects of currency variation. First, Neptune Plc is likely to face the challenge of currency fluctuation in South Africa. This is because sales will be made in the South African Currency, Rand, while production costs will be incurred in Euros. This means that the sales value has to be converted to Euros before the sales report is sent to the head office. The effect of fluctuations in exchange rates is likely to distort sales figure and lead to wrong impressions of performance. This is because by the time, financial statements are compiled and sent to the head office there shall have been numerous fluctuations in the Euro-Rand exchange rates. Secondly, Neptune is likely to import inflation from South Africa by continuing to report South Africa sales in Rand. If sales are made during periods of high inflation in South Africa, Neptune Plc will report these inflated figures, without adjusting them first before reporting. On conversion the sales and profits figures may not be accurate. Therefore, it could be advantageous if Neptune let costs to be incurred locally in South Africa, if it is possible. Secondly, the imported element of Neptune Plc’s production plant in Europe might lead to transfer pricing. Transfer prices go against the interests of any host country (Riahi-Belkaoui, 2002, p, 61). This might affect Neptune Plc’s relationships with South Africa, the Host country. Also, transaction risk is likely to result from this arrangement of Neptune Plc of allowing an imported element from its plant in Europe spread into South Africa. Transaction currency risk is a cash flow risk that relates to receivables, dividends and payables (Henderson, 2006, p, 140). This means that any exchange rate moves involving the two currencies, the Euro, and the Rand will distort the figures reported in financial statements, and affect Neptune Plc’s decision making. References Allen, L., 2009. The Encyclopedia of Money. Santa Barbara: ABC-CLIO Press. Bandelj, N., 2011. From Communists to Foreign Capitalists: The Social Foundations of Foreign Investment in Postsocialist Europe. Princeton: Princeton University Press. Blanchard, O., & Milesi-Ferretti, G. M., 2011, March 1. (Why) Should Current Account Balances Be Reduced? Retrieved from http://www.imf.org/external/pubs/ft/sdn/2011/sdn1103.pdf Blanchard, O., & Milesi-Ferretti, G. M., 2009, December 22. Global Imbalances: In Midstream? Retrieved from http://www.imf.org/external/pubs/ft/spn/2009/spn0929.pdf Cheng, J. L., Maitland, E., & Nicholas, S., 2009. 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R., 2013. Policies to Reduce a Current Account Deficit. Retrieved from http://www.economicshelp.org/macroeconomics/bop/policies-to-reduce-deficit/ Riahi-Belkaoui, A., 2002. Value Added Reporting: Lessons for the United States. New York: Quorum Books Press. Rupya Gyan., 2013, June 11. Current Account Deficit. Retrieved from http://rupyagyan.blogspot.com/2013/06/CAD.html Siddaiah, T., 2010. International Financial Management. Upper Saddle River: Pearson Publishers. Ulijn, J., Duysters, G., & Meijer, E., 2010. Strategic Alliances, Mergers and Acquisitions: The Influence of Culture on on Successful Cooperation. Cheltenham: Edward Elgar Publishers . Read More