InternationalFinancial Management1Jeff Madura10th EditionPrepared By: M. Kashif Khurshid (Lecturer NUML)Chapter 1:Multinational Financial Management:An Overview

What is Finance?*Finance can be defined as the art and science of managing the money.Finance is concerned with the process, institutions, markets, and instruments involved in the transfer of money among individuals, businesses, and governments.The science that describes the management, creation and study of money, banking, credit, investments, assets and liabilities. Finance consists of financial systems, which include the public, private and government spaces, and the study of finance and financial instruments, which can relate to countless assets and liabilities. Some prefer to divide finance into three distinct categories: public finance, corporate finance and personal finance. All three of which would contain many sub-categories.

DEFINITION OF INTERNATIONAL FINANCE*International finance is the branch of economics that studies the dynamics of foreign exchange, foreign direct investment and how these affect international trade.It also includes the study of international projects, international investments and the international capital flows.International finance (also referred to as international monetary economics or international macroeconomics) is the branch of financial economics broadly concerned with monetary and macroeconomic interrelations between two or more countries

DEFINITION OF INTERNATIONAL FINANCE*International Finance can be broadly defined, as the study of the financial decisions taken by a multinational corporation in the area of international business i.e. global corporate finance.

REASONS TO STUDY INTERNATIONAL FINANCE*To understand the global economyTo understand the effect of Global Finance on businessTo make intelligent decisions

CLASSIFICATION OF INTERNATIONAL BUSINESS OPERATIONS*The international business firms are broadly divided into three categories:International FirmMultinational firmTransnational Firm(a) International FirmThe traditional activity of an international firm involves importing and exporting. Goods are produced in the domestic market and then exported to foreign buyers.Financial management problems of this basic international trade activity focus on the payment process between the foreign buyer (seller) and domestic seller (buyer).

CLASSIFICATION OF INTERNATIONAL BUSINESS OPERATIONS*(b) Multinational firmAs international business expands, the firm needs to be closer to the consumer, closer to cheaper sources of inputs, or closer to other producers of the same product and gain from their activities. It needs to produce abroad as well as sell abroad. As the domestic firm expands its operations across borders, incorporating activities in other countries, it is classified as a multinational firm.

(c)Transnational FirmAs the multinational firm expands its branches, affiliates, subsidiaries, and network of suppliers, consumers, distributors and all others, which fall under the firms umbrella of activities.Firms like Unilever, Phillips, Ford, and Sony have become intricate network with home offices defined differently for products, processes, capitalization and even taxation.

Multinational Corporations*Multinational corporations (MNCs) are defined as

firms that engage in some form of international business.Their managers conduct international financial management, which involves international investing and financing decisions those are intended to maximize the value of the MNC.The goal of their managers is to maximize the value of the firm, which is similar to the goal of managers employed by domestic companies.

Chapter Objectives*To identify the main goal of the multinational corporation (MNC) and conflicts with that goal;To describe the key theories that justify international business; andTo explain the common methods used to conduct international business.To provide a model for valuing the MNC.

Goal of the MNC*The commonly accepted goal of an MNC is to maximize shareholders wealth.This book is focused on MNCs those are based in the United States and wholly own their foreign subsidiaries.

Conflicts Against the MNC Goal*For corporations with shareholders who differ from their managers, a conflict of goals can exist - the agency problem.Agency costs are normally larger for MNCs than for purely domestic firms.The scattering of distant subsidiaries.The sheer size of the MNC.The culture of foreign managers.Subsidiary value versus overall MNC value.

Impact of Management Control*The magnitude of agency costs can vary with the management style of the MNC.A centralized management style reduces agency costs. However, a decentralized style gives more control to those managers who are closer to the subsidiarys operations and environment.

Centralized Multinational Financial Management*For an MNC with two subsidiaries, A and B

Decentralized Multinational Financial Management*For an MNC with two subsidiaries, A and B

Impact of Management Control*Some MNCs attempt to strike a balance - they allow subsidiary managers to make the key decisions for their respective operations, but the decisions are monitored by the parents management.Electronic networks make it easier for the parent to monitor the actions and performance of foreign subsidiaries.For example, corporate intranet or internet email facilitates communication. Financial reports and other documents can be sent electronically too.

Impact of Management Control*Various forms of corporate control can reduce agency costs.Stock compensation for board members and executives.The threat of a hostile takeover.Monitoring and intervention by large shareholders.

Constraints Interfering with the MNCs Goal*As MNC managers attempt to maximize their firms value, they may be confronted with various constraints.Environmental constraints.Regulatory constraints.Ethical constraints.

Theories of International Business*Why are firms motivated to expand their business internationally?Theory of Comparative Advantage:Specialization by countries can increase production efficiency.

Imperfect Markets Theory:The markets for the various resources used in production are imperfect.

Product Cycle Theory:As a firm matures, it may recognize additional opportunities outside its home country.

The International Product Life Cycle*

InternationalBusiness MethodsInternational trade is a relatively conservative approach involving exporting and/or importing.The internet facilitates international trade by enabling firms to advertise and manage orders through their websites.

There are several methods by which firms can conduct international business.*

InternationalBusiness MethodsLicensing allows a firm to provide its technology in exchange for fees or some other benefits.Franchising obligates a firm to provide a specialized sales or service strategy, support assistance, and possibly an initial investment in the franchise in exchange for periodic fees.

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InternationalBusiness MethodsFirms may also penetrate foreign markets by engaging in a joint venture (joint ownership and operation) with firms that reside in those markets.Acquisitions of existing operations in foreign countries allow firms to quickly gain control over foreign operations as well as a share of the foreign market.

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InternationalBusiness MethodsFirms can also penetrate foreign markets by establishing new foreign subsidiaries.In general, any method of conducting business that requires a direct investment in foreign operations is referred to as a direct foreign investment (DFI).The optimal international business method may depend on the characteristics of the MNC.

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International OpportunitiesInvestment opportunities - The marginal return on projects for an MNC is above that of a purely domestic firm because of the expanded opportunity set of possible projects from which to select.Financing opportunities - An MNC is also able to obtain capital funding at a lower cost due to its larger opportunity set of funding sources around the world.

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Exposure to International Risk exchange rate movementsExchange rate fluctuations affect cash flows and foreign demand.

foreign economiesEconomic conditions affect demand.

political riskPolitical actions affect cash flows.

International business usually increases an MNCs exposure to:*

Managing for ValueLike domestic projects, foreign projects involve an investment decision and a financing decision.When managers make multinational finance decisions that maximize the overall present value of future cash flows, they maximize the firms value, and hence shareholder wealth.

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Valuation Model for an MNCDomestic Model

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Valuation Model for an MNCValuing International Cash Flows

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Valuation Model for an MNCAn MNCs financial decisions include how much business to conduct in each country and how much financing to obtain in each currency.Its financial decisions determine its exposure to the international environment.

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Valuation Model for an MNC*

How Chapters Relate to Valuation*

Chapter ReviewGoal of the MNCConflicts Against the MNC GoalImpact of Management ControlImpact of Corporate Control Constraints Interfering with the MNCs GoalTheories of International BusinessTheory of Comparative AdvantageImperfect Markets TheoryProduct Cycle Theory

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Chapter ReviewInternational Business Methods:International TradeLicensingFranchisingJoint VenturesAcquisitions of Existing OperationsEstablishing New Foreign Subsidiaries

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Chapter ReviewExposure to International RiskExposure to Exchange Rate MovementsExposure to Foreign EconomiesExposure to Political Risk Managing for Value

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Chapter ReviewValuation Model for an MNCDomestic ModelValuing International Cash FlowsImpact of Financial Management and International Conditions on ValueHow Chapters Relate to Valuation

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