International Financial Management

MzF

©2000 South-Western College Publishing

2

Part IThe International Financial Environment

Multinational Corporation (MNC)

Foreign Exchange Markets

Product Markets Subsidiaries InternationalFinancialMarkets

DividendRemittance& FinancingExporting

& ImportingInvesting

& Financing

CHAPTER 1

Multinational Financial Management:An Overview

4

Chapter Objectives

• To identify the main goal of the MNC and conflicts with that goal;

• To describe the key theories that justify international business; and

• To explain the common methods used to conduct international business.

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Goal of the MNC

• The commonly accepted goal of an MNC is to maximize shareholder wealth.

• 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, but can vary with the management style of the MNC.

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Goal of the MNC

• Various forms of corporate control can reduce agency problems - stock compensation, threat of hostile takeover, monitoring by large shareholders.

• As MNC managers attempt to maximize their firm’s value, they may be confronted with various environmental, regulatory, or ethical constraints.

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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.”

Theories of International Business

• Product Cycle Theory

Firm creates product to accommodate local demand.

1Firm exports product to accommodate foreign demand.

2

Firm establishes foreign subsidiary to establish presence in foreign country and possibly to reduce costs.

3

Firm differentiates product from competitors and/or expands product line in foreign country.

4a

Firm’s foreign business declines as its competitive advantages are eliminated.

4bor

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International Business Methods

• International Trade - a relatively conservative approach involving exporting and/or importing.

• Licensing - provision of technology in exchange for fees or some other benefits.

• Franchising - provision of 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

• Joint Ventures - joint ownership and operation by two or more firms.

• Acquisitions of Existing Operations

• Establishing New Foreign Subsidiaries

Any method of increasing international business that requires a direct investment in foreign operations normally is referred to as a direct foreign investment (DFI).

International OpportunitiesCost-benefit Evaluation for

Purely Domestic Firms versus MNCs

Marginal Return on

Projects

Marginal Cost of Capital

Purely Domestic Firm

Purely Domestic Firm

MNC

MNC

Appropriate Size for Purely Domestic Firm

Appropriate Size for MNC

X YAsset Level of Firm

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International Opportunities

• Opportunities in Europe¤ Single European Act of 1987¤ Removal of the Berlin Wall in 1989¤ Single currency system in 1999

• Opportunities in Latin America¤ North American Free Trade Agreement

(NAFTA) of 1993¤ General Agreement on Tariffs and Trade

(GATT) accord

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International Opportunities

• Opportunities in Asia¤ Significant growth expected for China¤ Asian economic crisis in 1997-1998

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Exposure to International Risk

• Exposure to Exchange Rate Movements¤ exchange rate fluctuations affect cash

flows and foreign demand

• Exposure to Foreign Economies¤ economic conditions affect demand

• Exposure to Political Risk¤ political actions affect cash flows

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Overview of an MNC’s Cash Flows

Profile A: MNCs focused on International Trade

U.S. Businesses

Foreign Importers

U.S. Customers

Foreign Exporters

U.S.-based MNC

$ for products

$ for supplies

$ for exports

$ for imports

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Overview of an MNC’s Cash Flows

Profile B: MNCs focused on International Trade and International Arrangements

U.S. Businesses

Foreign Importers

U.S. Customers

Foreign Exporters

Foreign Firms

U.S.-based MNC

$ for products

$ for supplies

$ for exports

$ for imports

$ for service

cost of service

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Overview of an MNC’s Cash Flows

Profile C: MNCs focused on International Trade, International Arrangements, and Direct Foreign Investment

U.S. Businesses

Foreign Importers

U.S. Customers

Foreign Exporters

Foreign Firms

Foreign Subsidiaries

U.S.-based MNC

$ for products

$ for supplies

$ for exports

$ for imports

$ for service

cost of service

funds remitted

funds invested

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Valuation Model for an MNC

• Domestic Model

Value = E CF$,

=

tt

t

n

k11

where E (CF$,t ) = expected cash flows to be received at the end of period t n = the number of periods into the future in which cash flows are received k = the required rate of return by investors

Valuation Model for an MNC

• Valuing International Cash Flows

Value =

E CF E ER, ,

=

j t j tj

m

tt

n

k

1

1 1

where E (CFj,t ) = expected cash flows denominated in currency j to be received by the U.S. parent at the end of period t E (ERj,t ) = expected exchange rate at which currency j can be converted to dollars at the end of period t k = the weighted average cost of capital of the U.S. parent company

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Valuation Model for an MNC

Impact of New International Opportunities on an MNC’s Value

Value =

E CF E ER, ,

=

j t j tj

m

tt

n

k

1

1 1

More Exposure to Exchange Rate Risk

New International Opportunities

More Exposure to Political Risk

More Exposure to Foreign Economies

How Chapters Relate to Valuation

Background on

International Financial Markets

(Chapters 2-5)

Exchange Rate Behavior

(Chapters 6-8)

Long-Term Investment and

Financing Decisions

(Chapters 13-18)

Short-Term Investment and

Financing Decisions

(Chapters 19-21)

Exchange Rate Risk Management

(Chapters 9-12)

Risk and Return of

MNC

Value and Stock Price

of MNC

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Chapter Review

• Goal of the MNC¤ Conflicts against the MNC Goal¤ Impact of MNC’s Management Style on

Agency Costs¤ Impact of Corporate Control on Agency

Costs¤ Constraints Interfering with the MNC’s Goal

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Chapter Review

• Theories of International Business¤ Theory of Comparative Advantage¤ Imperfect Markets Theory¤ Product Cycle Theory

• 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¤ Opportunities in Europe¤ Opportunities in Latin America¤ Opportunities in Asia

• Exposure to International Risk¤ Exposure to Exchange Rate Movements¤ Exposure to Foreign Economies¤ Exposure to Political Risk

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Chapter Review

• Overview of an MNC’s Cash Flows

• Valuation Model for an MNC¤ Domestic Model¤ Valuing International Cash Flows¤ How Chapters Relate to Valuation