© McGraw Hill Companies, Inc., 2000 Financial Management in the International Business Chapter 20.
-
Upload
alexa-brockman -
Category
Documents
-
view
216 -
download
1
Transcript of © McGraw Hill Companies, Inc., 2000 Financial Management in the International Business Chapter 20.
© McGraw Hill Companies, Inc., 2000
Financial Management in the International Business
Chapter 20
© McGraw Hill Companies, Inc., 2000
Introduction
Scope of financial management includes three sets of related decisions: Investment decisions, decisions about what
activities to finance. Financing decisions, decisions about how to
finance those activities. Money management decisions, decisions about
how to manage the firm’s financial resources most efficiently.
20-1
© McGraw Hill Companies, Inc., 2000
Investment Decisions Capital budgeting:
quantifies the benefits, costs and risks of an investment. Managers can reasonably compare different investment
alternatives within and across countries.
Complicated process: Must distinguish between cash flows to project and those to parent. Political and economic risk can change the value of a foreign
investment. Connection between cash flows to parent and the source of
financing must be recognized.
20-2
© McGraw Hill Companies, Inc., 2000
Project and Parent Cash Flows
Project cash flows may not reach the parent: Host-country may block cash-flow
repatriation. Cash flows may be taxed at an
unfavorable rate. Host government may require a
percentage of cash flows to be reinvested in the host country.
20-3
© McGraw Hill Companies, Inc., 2000
Adjusting for Political and Economic Risk
Political risk: Expropriation - Iranian revolution, 1979. Social unrest - after the breakup of Yugoslavia,
company assets were rendered worthless. Political change - may lead to tax and
ownership changes.
20-4
© McGraw Hill Companies, Inc., 2000
Euromoney Magazine’s Country Risk Ratings
0102030405060708090100
Lux
USA Ger
Neth
Bermuda
Benin
Azerbaijan
Madagascar
Adapted from Table 20.1 in text
Highest and lowest ranked countries.
Total score = 100
20-5
© McGraw Hill Companies, Inc., 2000
Financing Decisions (a) Source of financing:
Global capital markets for lower cost financing. Host-country may require projects to be locally
financed through debt or equity.• Limited liquidity raises the cost of capital.
• Host-government may offer low interest or subsidized loans to attract investment.
Impact of local currency (appreciation/depreciation) influences capital and financing decisions.
20-6
© McGraw Hill Companies, Inc., 2000
Financing Decisions (b) Financial structure:
Debt/equity ratios vary with countries.• Tax regimes.
Follow local capital structure norms?• More easily evaluate return on equity relative to
local competition.
• Good for company’s image.
Best recommendation: adopt a financial structure that minimizes its cost of capital.
20-7
© McGraw Hill Companies, Inc., 2000
Debt Ratios for Selected Industrial Countries
00.1
0.20.30.40.5
0.60.70.8
Singapore
Malaysia
Argentina
Australia
Finland
Pakistan
Norway
Italy
Highest and lowest ranked countries.
Debt ratio = total debt / total assets at book value.
Country Mean
Adapted from Table 20.2 in text
20-8
© McGraw Hill Companies, Inc., 2000
Global Money Management(The Efficiency Objective)
Minimizing cash balances: Money market accounts - low interest - high
liquidity. Certificates of deposit - higher interest - lower
liquidity.
Reducing transaction costs (cost of exchange): Transaction costs:changing from one currency to
another. Transfer fee: fee for moving cash from one location
to another.20-9
© McGraw Hill Companies, Inc., 2000
Global Money Management(The Tax Objective)
Countries tax income earned outside their boundaries by entities based in their country. Can lead to double taxation. Tax credit allows entity to reduce home taxes by amount paid
to foreign government. Tax treaty is an agreement between countries specifying what
items will be taxed by authorities in country where income is earned.
Deferral principle specifies that parent companies will not be taxed on foreign income until the dividend is received.
Tax haven is used to minimize tax liability.20-10
© McGraw Hill Companies, Inc., 2000
OECD Corporate Income Tax Rates
0
10
20
30
40
50
60Germany
Italy
Japan
Canada
Finland
Norway
Sweden
Swiss
USA
Top Tax Rate %
Highest and lowest ranked countries and USA.Adapted
from Table 20.3 in text
20-11
© McGraw Hill Companies, Inc., 2000
Moving Money Across Borders: Attaining Efficiencies and Reducing
Taxes Unbundling: a mix of techniques to transfer
liquid funds from a foreign subsidiary to the parent company without piquing the host-country. Dividend remittances. Royalty payments and fees. Transfer Prices. Fronting loans.
20-12
© McGraw Hill Companies, Inc., 2000
Dividend Remittances Most common method of transfer.
Dividend varies with:
tax regulations.
Foreign exchange risk.
Age of subsidiary.
Extent of local equity participation.
Dividends
20-13
© McGraw Hill Companies, Inc., 2000
Royalty Payments and Fees Royalties represent the remuneration paid to
owners of technology, patents or trade names for their use by the firm. Common for parent to charge a subsidiary for
technology, patents or trade names transferred to it. May be levied as a fixed amount per unit sold or
percentage of revenue earned.
Fees are compensation for professional services or expertise supplied to subsidiary. Management fees or ‘technical assistance’ fees. Fixed charges for services provided
20-14
© McGraw Hill Companies, Inc., 2000
Transfer Prices
Price at which goods or services are transferred within a firm’s entities. Position funds within a company.
• Move founds out of country by setting high transfer fees or into a country by setting low transfer fees.
Movement can be within subsidiaries or between the parent and its subsidiaries.
20-15
© McGraw Hill Companies, Inc., 2000
Benefits of Transfer Fees Reduce tax liabilities by using transfer fees to
shift from a high-tax country to a low-tax country.
Reduce foreign exchange risk exposure to expected currency devaluation by transferring funds.
Can be used where dividends are restricted or blocked by host-government policy.
Reduce import duties (ad valorem) by reducing transfer prices and the value of the goods.
20-16
© McGraw Hill Companies, Inc., 2000
Problems with Transfer Pricing
Few governments like it. Believe (rightly) that they are losing revenue.
Has an impact on management incentives and performance evaluations. Inconsistent with a ‘profit center’. Managers can hide inefficiencies.
20-17
© McGraw Hill Companies, Inc., 2000
Fronting Loans
A loan between a parent and subsidiary is channeled through a financial intermediary (bank). Can circumvent host-country restrictions on
remittance of funds from subsidiary to parent. Provides certain tax advantages.
20-18
© McGraw Hill Companies, Inc., 2000
An Example of the Tax Aspects of a Fronting Loan
Tax Haven
Subsidiary
London Bank
Foreign Operating Subsidiary
Pays 8% Interest (Tax Free)
Pays 9% Interest (Tax Deductible)
Deposit $1 Million
Loan $1 Million
Figure 20.1
20-19
© McGraw Hill Companies, Inc., 2000
Techniques for Global Money Management Centralized Depositories
Need cash reserves to service accounts and insuring against negative cash flows.
Should each subsidiary hold its own cash balance? By pooling, firm can deposit larger cash amounts and
earn higher interest rates. If located in a major financial center can get
information on good investment opportunities. Can reduce the total size of cash pool and invest larger
reserves in higher paying, long term, instruments.
20-20
© McGraw Hill Companies, Inc., 2000
Centralized Depositories
Day-to-Day Cash Needs (A)
One Standard Deviation
(B)
Required Cash
Balance (A+3xB)
Spain $10 $1 $13
Italy $ 6 $2 $12
Germany $12 $3 $21
Total $28 $6 $46
20-21
© McGraw Hill Companies, Inc., 2000
Techniques for Global Money Management Multilateral Netting
Ability to reduce transaction costs. Bilateral netting. Multilateral netting - simply
extending the bilateral concept to multiple subsidiaries within an international business.
20-22
© McGraw Hill Companies, Inc., 2000
Cash Flows before Multilateral Netting
German Subsidiary
French Subsidiary
ItalianSubsidiary
SpanishSubsidiary
$4 Million
$1 Million
$3 Million
$2 Million
$5 Million $3 Million$4 Million$5 Million$2 M
illion
$5 Million
$6 Million
$3 Millio
n
Figure 20.2a
20-23
© McGraw Hill Companies, Inc., 2000
Calculation of Net Receipts($ Million)
Paying SubsidiaryReceiving
Subsidiary
Germany France Spain ItalyTotal Receipts
Net Receipts* (payments)
Germany - $3 $4 $5 $12 ($3)France $4 - 2 3 9 (2)Spain 5 3 - 1 9 1Italy 6 5 2 - 13 4Total payments $15 $11 $8 $9
Net receipts = Total payments - total receipts
Figure 20.2b
20-24
© McGraw Hill Companies, Inc., 2000
Cash Flows after Multilateral Netting
German Subsidiary
French Subsidiary
SpanishSubsidiary
ItalianSubsidiary
Pays $1
Million
Pays $3 MillionPays $1 Million
Figure 20.2c
20-25
© McGraw Hill Companies, Inc., 2000
Managing Foreign Exchange Risk
Risk that future changes in a country’s exchange rate will hurt the firm. Transaction exposure:extent income from
transactions is affected by currency fluctuations. Translation exposure:impact of currency
exchange rates on consolidated results and balance sheet.
Economic exposure:effect of changing exchange rates over future prices, sales and costs.
20-26
© McGraw Hill Companies, Inc., 2000
Strategies for Reducing Foreign Exchange Risk (a)
Primarily protect short-term cash flows. Reducing transaction and translation exposure:
Buying forward and currency swaps. Lead strategy:collecting receivables early when
currency devaluation is anticipated and paying early when currency may appreciate.
Lag strategy:delaying receivable collection when anticipating currency appreciation and delaying payables when currency depreciation is expected.
20-27
© McGraw Hill Companies, Inc., 2000
Strategies for Reducing Foreign Exchange Risk (b)
Reducing economic exposure: Key is to distribute productive assets to various
locations so firm is not severely affected by exchange rate changes.
Manufacturing Facility Dispersal
20-28
© McGraw Hill Companies, Inc., 2000
Managing Foreign Exchange Exposure
No agreement as to how, but commonality of approach does exist: Central control of exposure. Distinguish between transaction/translation
exposure and economic exposure. Forecast future exchange rate movements. Good reporting systems to monitor firm’s exposure
to exchange rate changes. Produce monthly foreign exchange exposure reports.
20-29