Calculating a Foreign Division’s ROI in U.S. Dollars

One way to make a comparison of historical-cost-based ROIs more meaningful is to restate HIMC’s performance in U.S. dollars. But what exchange rate should the managers use to make the comparison meaningful? Assume HIMC’s operating income was earned evenly throughout 2020. Hospitality Inns’ managers should use the average exchange rate of $25 \text{pesos}=\$1$ to convert the operating income from pesos to dollars: $\text{6,000,000} \text{pesos}÷25 \text{pesos per dollar}=\$\text{240,000}.$ The effect of dividing the operating income in pesos by the higher pesos-to-dollar exchange rate prevailing during 2020, rather than the $20 \text{\hspace{0.05em}pesos}=\$1$ exchange rate on December 31, 2019, is that any increase in operating income in pesos as a result of inflation during 2020 is eliminated when converting back to dollars.

At what rate should HIMC’s total assets of 30,000,000 pesos be converted? They should be converted at the $20 \text{pesos}=\$1$ exchange rate, which was the exchange rate when the assets were acquired on December 31, 2019. Why? Because HIMC’s assets are recorded in pesos at the December 31, 2019, cost, and the assets are not revalued as a result of inflation in Mexico in 2020. Since the subsequent inflation does not affect the cost of assets in HIMC’s financial accounting records, managers should use the exchange rate prevailing on the date the assets were acquired to convert the assets into dollars. Using exchange rates after December 31, 2019, would be incorrect because these exchange rates incorporate the higher inflation in Mexico in 2020. HIMC’s total assets are therefore $1,500,000 $(\text{30,000,000} \text{pesos} ÷ \mathrm{20 } \text{pesos per dollar}).$

Then

With these adjustments, the historical-cost-based ROIs of the Mexico City and New Orleans hotels are comparable because they negate the effects of differential inflation rates in the two countries. Now HIMC’s ROI is less than HINO’s (16% versus HINO’s ROI of 17%).

Calculating residual income in pesos poses the same problems as calculating the ROI in pesos does. Calculating HIMC’s RI in dollars adjusts for changes in exchange rates and makes for more-meaningful comparisons with Hospitality’s other hotels:

which is also less than HINO’s RI of $150,000.

Keep in mind that HIMC’s and HINO’s ROIs and RIs are historical-cost-based calculations. However, both hotels are relatively new, so this is less of a concern.