Part I: The International Financial Environment
description
Transcript of Part I: The International Financial Environment
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Multinational Corporation (MNC)
Foreign Exchange Markets
Product Markets Subsidiaries InternationalFinancialMarkets
DividendRemittance& FinancingExporting
& ImportingInvesting
& Financing
Part I: The International Financial Environment
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Chapter 1: OverviewChapter 1: Overview
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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 wholly own their foreign subsidiaries.
Financial managers throughout the MNChave a single goal of maximizing the value of the entire MNC.
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Conflicts with the MNC Goal
• When a corporation’s shareholders differ from its managers, a conflict of goals can exist: the agency problem.
• Agency costs are normally larger for MNCs than for purely domestic firms, due to:
1. the difficulty in monitoring distant managers,2. the different cultures of foreign managers,3. the size of the larger MNCs, and4. the tendency to downplay short-term effects.
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Conflicts with the MNC Goal
• Subsidiary managers may be tempted to make decisions that maximize the values of their respective subsidiaries.
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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 reduces agency costs.
• However, a decentralized style gives more control to those managers who are closer to the subsidiary’s operations and environment.
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Centralized Multinational Financial Management
for an MNC with two subsidiaries, A and B
FinancialManagersof Parent
Capital Expendituresat A
Inventory andAccounts
ReceivableManagement at A
CashManagement
at A
Financing at A
Capital Expendituresat B
Inventory andAccounts
ReceivableManagement at B
CashManagement
at B
Financing at B
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Decentralized Multinational Financial Managementfor an MNC with two subsidiaries, A and B
FinancialManagers
of A
Capital Expendituresat A
Inventory andAccounts
ReceivableManagement at A
CashManagement
at A
Financing at A
Capital Expendituresat B
Inventory andAccounts
ReceivableManagement at B
CashManagement
at B
Financing at B
FinancialManagers
of B
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Impact of Management Control
• Some MNCs attempt to strike a balance:– allowing subsidiary managers to make the
key decisions for their respective operations
– the parent’s management monitors the decisions.
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Impact of Corporate Control
• Various forms of corporate control can reduce agency costs:– stock options (for the board members
and executives)
– hostile takeover threat (especially for firms with low stock prices)
– investor monitoring (banks, mutual funds, pension funds)
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Constraints Interfering with the MNC’s Goal
• MNC managers are confronted with various constraints:– environmental constraints (anti-
pollution)– regulatory constraints (taxes,
currency convertibility, earnings remittance, employee rights)
– ethical constraints (bribes)
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Why are firms motivated to expand their business internationally?
Theories of International Business
Theory of Comparative Advantage– Specialization by countries can increase
production efficiency.
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Imperfect Markets Theory– The markets for the various
resources used in production are “imperfect.” (factors of production are immobile, e.g. land)
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Product Cycle Theory– As a firm matures, it may recognize
additional opportunities outside its home country.
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Firm exports product to accommodate foreign demand
Firm creates product to accommodate local demand
The International Product Life Cycle
Firm establishes foreign subsidiary to establish presence in foreign country and possibly to reduce costs
a. Firm differentiates product from competitors and/or expands product line in foreign country
b. Firm’s foreign business declines as its competitive advantages are eliminated
or
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InternationalBusiness Methods
International trade involves exporting and/or importing.
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 exchange for periodic fees.
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Firms 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.
InternationalBusiness Methods
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Firms 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).
InternationalBusiness Methods
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International Opportunities
• Investment opportunities– The marginal returns on MNC projects are
above those of purely domestic firms since MNCs have expanded opportunity sets of possible projects from which to select.
• Financing opportunities– MNCs can obtain capital funding at a lower
cost due to their larger opportunity set of funding sources around the world.
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Marginal Return on
Projects
Purely Domestic Firm
MNC
Asset Levelof Firm
InvestmentOpportunities
International OpportunitiesCost-Benefit Evaluation for
Purely Domestic Firms versus MNCs
Appropriate Size for Purely Domestic Firm
Appropriate Size for MNC
X Y
Marginal Cost of Capital
Purely Domestic Firm MNC
FinancingOpportunities
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International Opportunities
• Opportunities in Europe– the Single European Act of 1987– the removal of the Berlin Wall in 1989– the inception of the euro in 1999– the expansion of the European Union
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International Opportunities
• Opportunities in Latin America– the North American Free Trade
Agreement (NAFTA) of 1993
• Opportunities in Asia– the growth of China– the impact of the Asian crisis in 1997-
1998
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Exposure to International Risk
• International business usually increases an MNC’s exposure to: exchange rate movements foreign economies political risk
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Overview of an MNC’s Cash Flows
Profile A: MNCs focused on International Trade
U.S.-based MNC
U.S. CustomersPayments for products
U.S. BusinessesPayments for supplies
Foreign ImportersPayments for exports
Foreign ExportersPayments for imports
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Overview of an MNC’s Cash FlowsProfile B: MNCs focused on International Trade and
International Arrangements
U.S.-based MNC
U.S. CustomersPayments for products
U.S. BusinessesPayments for supplies
Foreign ImportersPayments for exports
Foreign ExportersPayments for imports
Foreign FirmsFees for services provided
Fees for services received Foreign Firms
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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.-based MNC
U.S. CustomersPayments for products
U.S. BusinessesPayments for supplies
Foreign ImportersPayments for exports
Foreign ExportersPayments for imports
Foreign SubsidiariesFunds remitted back
Foreign FirmsFees for services provided
Fees for services received Foreign Firms
Investment funds Foreign Subsidiaries
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n
ttt
k1=
$,
1
CF E = Value
E (CF$,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
jtjtj
k1=
1 , ,
1
ER ECF E
= Value
E (CFj,t ) = expected cash flows denominated in currency j to be received by the U.S. parent at the end of period tE (ERj,t ) = expected exchange rate at which currency j can be converted to dollars at the end of period tk = the weighted average cost of capital of the MNC
Valuation Model for an MNC• Valuing International Cash Flows
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Organization of the Text
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