Multinational Financial Management: An Overview

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Chapter1Multinational Financial Management:An OverviewJ. Gaspar: Adapted from Jeff Madura, International Financial Management1. 1

Global GeopoliticalEnvironment & InformationTechnologyInternationalMonetary SystemInternationalFinancialManagement1.2

Chapter Objectives To identify the main goal of the multinationalcorporation (MNC) and potential conflictswith that goal;To describe the key theories that justifyinternational business; andTo explain the common methods used toconduct international business.1. 3

Goal of the MNC The commonly accepted goal of an MNC is tomaximize shareholder wealth. We will focus on MNCs that wholly own theirforeign subsidiaries. Financial managers throughout the MNC:have a single goal of maximizing the value of theentire MNC.1. 4

Conflicts with the MNC Goal When a corporation’s shareholders differ from itsmanagers, a conflict of goals can exist—the agencyproblem. Agency costs are normally larger for MNCs than forpurely domestic firms, due to: the difficulty in monitoring distant managers, the different cultures of foreign managers, the sheer size of the larger MNCs, and the tendency to downplay short-term effects.1. 5

Conflicts with the MNC Goal Subsidiary managers may be tempted to makedecisions that maximize the values of theirrespective subsidiaries.1. 6

Impact of Management Control The magnitude of agency costs can vary with themanagement style of the MNC. A centralized management style reduces agency costs.However, a decentralized style gives more control tothose managers who are closer to the subsidiary’soperations and environment.1.7

Centralized Multinational FinancialManagementfor an MNC with two subsidiaries, A and BCashManagementat AInventory andAccountsReceivableManagement at AFinancing at ACapital Expendituresat AFinancialManagersof ParentCashManagementat BInventory andAccountsReceivableManagement at BFinancing at BCapital Expendituresat B1. 8

Decentralized Multinational FinancialManagementfor an MNC with two subsidiaries, A and BCashManagementat AInventory andAccountsReceivableManagement at AFinancing at ACapital Expendituresat AFinancialManagersof AFinancialManagersof BCashManagementat BInventory andAccountsReceivableManagement at BFinancing at BCapital Expendituresat B1. 9

Impact of Management Control Some MNCs attempt to strike a balance – theyallow subsidiary managers to make the keydecisions for their respective operations, but theparent’s management monitors the decisions. Today, electronic networks make it easier for theparent to monitor the actions and performance ofits foreign subsidiaries.1.10

Impact of Corporate Control Various forms of corporate control can reduceagency costs: stock options hostile takeover threat investor monitoring1.11

Constraints Interfering withthe MNC’s Goal MNC managers are confronted with variousconstraints: environmental constraints regulatory constraints ethical constraints A recent study found that investors assigned ahigher value to firms that exhibit high corporategovernance standards and are likely to obeyethical constraints.1.12

Theories of InternationalBusinessWhy are firms motivated to expandtheir business internationally? Theory of Comparative Advantage Specialization by countries can increase productionefficiency. Imperfect Markets Theory The markets for the various resources used inproduction are “imperfect.”1.13

Theories of InternationalBusinessWhy are firms motivated to expandtheir business internationally? Product Cycle Theory As a firm matures, it may recognize additionalopportunities outside its home country.1.14

The International Product Life Cycle Firm createsproduct toaccommodatelocal demand a. Firmdifferentiates productfrom competitorsand/or expandsproduct line in foreigncountry Firm exportsproduct toaccommodateforeign demand Firm establishesforeign subsidiary toestablish presence inforeign country andpossibly to reducecostsor b. Firm’sforeign businessdeclines as itscompetitiveadvantages areeliminated1.15

InternationalBusiness Methods International trade involves exporting and/orimporting. Licensing allows a firm to provide its technology inexchange for fees or some other benefits. Franchising obligates a firm to provide aspecialized sales or service strategy, supportassistance, and possibly an initial investment, inexchange for periodic fees.1.16

InternationalBusiness Methods Firms may also penetrate foreign markets byengaging in a joint venture (joint ownershipand operation) with firms that reside in thosemarkets. Acquisitions of existing operations in foreigncountries allow firms to quickly gain controlover foreign operations as well as a share ofthe foreign market.1.17

InternationalBusiness Methods Firms can also penetrate foreign markets byestablishing new foreign subsidiaries. Many MNCs use a combination of methods toincrease international business. In general, any method of conducting businessthat requires a direct investment in foreignoperations is referred to as a foreign directinvestment (FDI).1.18

International Opportunities Investment opportunities The marginal returns on MNC projects are abovethose of purely domestic firms since MNCs haveexpanded opportunity sets of possible projects fromwhich to select.Financing opportunities MNCs can obtain capital funding at a lower cost dueto their larger opportunity set of funding sourcesaround the world.1.19

International OpportunitiesCost-Benefit Evaluation forPurely Domestic Firms versus rginalReturn onProjectsMNCPurelyDomesticFirmMarginalCost ofCapitalAppropriate Size forPurely DomesticFirmFinancingOpportunitiesXAppropriate Size forMNCYAsset Levelof Firm1. 20

International Opportunities Opportunities in Europe the Single European Act of 1987 the fall of the Berlin Wall in 1989 the inception of the euro in 1999 the enlargement of the European Union the potential EU-US Free Trade Agreement1. 21

International Opportunities Opportunities in Latin America the North American Free Trade Agreement (NAFTA)of 1993 Central America Free Trade Area (CAFTA-DR);MERCOSUR; and FTA ColumbiaOpportunities in Asia the ASEAN Free Trade Area ASEAN-China/India/South Korean FTA the Trans Pacific Partnership (TPP)1. 22

Exposure to International Risk International business usually increases anMNC’s exposure to: exchange rate movements foreign economic risk political risk1. 23

Overview of an MNC’s Cash FlowsProfile A:MNCs Focused on International TradeU.S.basedMNCPayments for productsU.S. CustomersPayments for suppliesU.S. BusinessesPayments for exportsForeign ImportersPayments for importsForeign Exporters1. 24

Overview of an MNC’s Cash FlowsProfile B:MNCs Focused on International Trade and InternationalArrangementsU.S.basedMNCPayments for productsU.S. CustomersPayments for suppliesU.S. BusinessesPayments for exportsForeign ImportersPayments for importsForeign ExportersFees for services providedForeign FirmsFees for services receivedForeign Firms1. 25

Overview of an MNC’s Cash FlowsProfile C: MNCs Focused onInternational Trade, Income, and Direct Foreign InvestmentPayments for productsPayments for suppliesU.S.basedMNCPayments for exportsPayments for importsU.S. CustomersU.S. BusinessesForeign ImportersForeign ExportersFees for services providedForeign FirmsFees for services receivedForeign FirmsFunds remitted backForeign SubsidiariesInvestment fundsForeign Subsidiaries1. 26

Valuation Model for an MNC Domestic ModelnValue t 1E CF , t 1 k tE (CF ,t ) expected cash flows to be received at the end ofperiod tn the number of periods into the future in whichcash flows are receivedk the required rate of return by investors1. 27

Valuation Model for an MNC Valuing International Cash Flows m E CFj , t E ER j , t n j 1Value t 1 k t 1 E (CFj,t ) expected cash flows denominated in currency j to bereceived by the U.S. parent at the end of period tE (ERj,t ) expected exchange rate at which currency j can beconverted to dollars at the end of period tk the weighted average cost of capital of the MNC1. 28

Impact of Financial Management andInternational Conditions on Value An MNC will decide how much business to conduct in eachcountry and how much financing to obtain in each currency. The MNC’s financial decisions determine its exposure to theinternational environment. An MNC can control its degree of exposure to exchange rate effects, economic conditions, andpolitical conditions with its financial management.1. 29

Exchange RateBehavior (Chapters6-8)Background erm Investmentand FinancingDecisions (Chapters13-18)Exchange Rate RiskManagement (Chapters9-12)Risk andReturn ofMNCValue and StockPrice of MNCShort-Term Investmentand FinancingDecisions (Chapters19-21)1. 30

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 1.30

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