Skye Travel Agency specializes in tours for American tourists. Until recently, a
ID: 1213421 • Letter: S
Question
Skye Travel Agency specializes in tours for American tourists. Until recently, all of its business was in the Switzerland. It has just established a subsidiary in Athens, Greece, which provides tour services in the Greek islands for American tourists. It rented a shop near the port of Athens. It also hired residents of Athens, who could speak English and provide tours of the Greek islands. The subsidiary’s main costs are rent and salaries for its employees and the lease of a few large boats in Athens that it uses for tours. American tourists pay for the entire tour in dollars at Skye’s US office before they depart for Greece.
Required:
Explain why Skye may be able to effectively capitalize on international opportunities such as the Greek island tours.
(5 marks)
Skye is privately owned by owners who reside in the Switzerland and work in the main office. Explain possible agency problems associated with the creation of a subsidiary in Athens, Greece. How can Skye attempt to reduce these agency costs?
(5 marks)
Greece’s cost of labor and rent are relatively low. Explain why this information is relevant to Skye’s decision to establish a tour business in Greece.
(5 marks)
Explain how the cash flow situation of the Greek tour business exposes Skye to exchange rate risk. Is Skye favorably or unfavorably affected when the euro (Greece’s currency) appreciates against the dollar? Explain.
(5 marks)
Skye plans to finance its Greek tour business. Its subsidiary could obtain loans in euros from a bank in Greece to cover its rent, and its main office could pay off the loans over time. Alternatively, its main office could borrow dollars and would periodically convert dollars to euros to pay the expenses in Greece. Does either type of loan reduce the exposure of Skye to exchange rate risk? Explain.
(5 marks)
Explain how the Greek island tour business could expose Skye to country risk.
(5 marks)
Explanation / Answer
Answer:
a) Explain why Skye may be able to effectively capitalize on international opportunities such as the Greek island tours.
It already has established credibility with American tourists, but could penetrate a new market with some of the same customers that it has served on tours in the Switzerland.
b) Skye is privately owned by owners who reside in the Switzerland and work in the main office. Explain possible agency problems associated with the creation of a subsidiary in Athens, Greece. How can Skye attempt to reduce these agency costs?
The employees of the subsidiary in Athens are not owners, and may have no incentive to manage in a manner that maximizes the wealth of the owners. Thus, they may manage the tours inefficiently. Skye could attempt to allow the employees a portion of the ownership of the company so that they benefit more directly from good performance. Alternatively, Skye may consider having one of its owners transfer to Athens to oversee the subsidiary’s operations.
c) Greece’s cost of labor and rent are relatively low. Explain why this information is relevant to Skye’s decision to establish a tour business in Greece.
The low cost of rent and labor will be beneficial to Skye, because it enables Skye to create the subsidiary at a low cost.
d) Explain how the cash flow situation of the Greek tour business exposes Skye to exchange rate risk. Is Skye favorably or unfavorably affected when the euro (Greece’s currency) appreciates against the dollar? Explain.
Skye’s tour business in Greece results in dollar cash inflows and euro cash outflows. It will be adversely affected by the appreciation of the euro because it will require more dollars to cover the costs in Athens if the euro’s value rises.
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