Textbook Problem

MNC Cash Flows and Exchange Rate Risk Asheville Co. has a subsidiary in Mexico that develops software for its parent. It rents a large facility in Mexico and hires many people in Mexico to work in this facility. Asheville Co. has no other international business. All operations are presently funded by the parent company. All the software is sold to U.S. firms by the parent company and invoiced in U.S. dollars.

1. If the Mexican peso appreciates against the dollar, will this have a favorable effect, unfavorable effect, or no effect on Asheville’s value?
2. Asheville Co. plans to borrow funds to support its expansion in the United States. The Mexican interest rates are presently lower than U.S. interest rates, so Asheville obtains a loan denominated in Mexican pesos to support its expansion in the United States. Will the borrowing of pesos increase, decrease, or have no effect on its exposure to exchange rate risk? Briefly explain.