international financial management- an overview

7/29/2019 International Financial Management- An overview

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Multinational Financial Management:An Overview

1

Chapter

South-Western/Thomson Learning 2003


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Why is International Finance Important?

In previous finance courses you have beentaught about general finance concepts thatapply to domestic or local settings, BUT welive in an international world.

Companies (and individuals) can raise funds,invest money, buy inputs, produce goods and

sell products and services overseas.With these increased opportunities comes

additional risks. We need to know how toidentify these risks and then how to control or

remove them.


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What is different?


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Multinational Enterprises

A multinational enterprise (MNE) is definedas one that has operating subsidiaries,branches or affiliates located in foreigncountries.

While international finance focuses onMNEs, purely domestic firms can also facesignificant international exposures: Import & export of products, components and

services Licensing of foreign firms to conduct their

foreign business Exposure to foreign competition in the domestic

market Indirect exposure to international risks through

relationships with customers and suppliers


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Types of Multinational Enterprises

Raw Material Seekers First type of MNEs Exploit raw materials found overseas Trading, mining and oil companies

Market Seekers Post-WWII MNEs Expand production and sales into foreign markets Big name companies IBM, McDonalds etc.

Cost Minimisers

More recent MNEs Seek out lowest production cost countries Manufacturing and service companies


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Goal of the MNC

The commonly accepted goal of an MNC is

to maximize shareholder wealth.

We will focus on MNCs that are based inthe United States and that wholly own

their foreign subsidiaries.


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Conflicts Against the MNC Goal

For corporations with shareholders who

differ from their managers, a conflict of

goals can exist - theagency problem. Agency costs are normally larger for MNCs

than for purely domestic firms.

The sheer size of the MNC. The scattering of distant subsidiaries.

The culture of foreign managers.

Subsidiary value versus overall MNC value.


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Impact of Management Control

The magnitude of agency costs can vary

with the management style of the MNC.

A centralized management style reducesagency costs. However, a decentralized

style gives more control to those

managers who are closer to the

subsidiarys operations and environment.


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Some MNCs attempt to strike a balance -

they allow subsidiary managers to make

the key decisions for their respectiveoperations, but the decisions are

monitored by the parents management.


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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.


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Constraints

Interfering with the MNC

s Goal As MNC managers attempt to maximize

their firms value, they may be confronted

with various constraints. Environmental constraints.

Regulatory constraints.

Ethical constraints.


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Why are firms motivated to expandtheir business internationally?

Theories of International Business

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.


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Why are firms motivated to expandtheir business internationally?


Product Cycle Theory

As a firm matures, it may recognize

additional opportunities outside its home

country.


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International

Business Methods

International trade is a relativelyconservative approach involving

exporting and/or importing.

The internet facilitates international tradeby enabling firms to advertise and manage

orders through their websites.

There are several methods by which firmscan conduct international business.


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International

Business Methods Licensing 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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International

Business Methods Firms may also penetrate foreign markets

by engaging in ajoint venture (joint

ownership and operation) with firms thatreside 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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International

Business Methods Firms can also penetrate foreign markets

by establishing new foreign subsidiaries.

In general, any method of conductingbusiness 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 Opportunities

Investment opportunities - The marginal

return on projects for an MNC is above

that of a purely domestic firm because ofthe 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 movements Exchange rate fluctuations affect cash

flows and foreign demand.

foreign economies

Economic conditions affect demand.

political risk

Political actions affect cash flows.

International business usually increases anMNCs exposure to:


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Managing for Value

Like 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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n

ttt

k1=

$,

1CFE=Value

E (CF$,t ) = expected cash flows to be received at

the end of period tn = the number of periods into the future

in which cash flows are receivedk = the required rate of return by

investors

Valuation Model for an MNC

Domestic Model


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n

tt

m

j

tjtj

k1=

1

,,

1

ERECFE

=Value

E (CFj,t ) = expected cash flows denominated in currencyj

to be received by the U.S. parent at the end ofperiod t

E (ERj,t ) = expected exchange rate at which currencyj canbe converted to dollars at the end of period t

k = the weighted average cost of capital of the U.S.

parent company


Valuing International Cash Flows


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An MNCs financial decisions include how

much business to conduct in each country

and how much financing to obtain in eachcurrency.

Its financial decisions determine its

exposure to the international environment.


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Impact of New International Opportunitieson an MNCs Value

Exchange Rate Risk

n

t t

m

j

tjtj

k1=

1

,,

1

ERECFE

=Value

Political Risk

Exposure toForeign Economies


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Chapter Review

Goal of the MNC

Conflicts Against the MNC Goal

Impact of Management Control Impact of Corporate Control

Constraints Interfering with the MNCs

Goal


Theory of Comparative Advantage

Imperfect Markets Theory

Product Cycle Theory


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Chapter Review

International Business Methods

International Trade

Licensing Franchising

Joint Ventures

Acquisitions of Existing Operations

Establishing New Foreign Subsidiaries


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Chapter Review

International Opportunities

Investment Opportunities

Financing Opportunities Opportunities in Europe

Opportunities in Latin America

Opportunities in Asia


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Chapter Review

Exposure to International Risk

Exposure to Exchange Rate Movements

Exposure to Foreign Economies Exposure to Political Risk

Managing for Value


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Chapter Review


Domestic Model

Valuing International Cash Flows Impact of Financial Management and

International Conditions on Value

international financial management- an overview

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