session 04 1

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Madura: International Financial Management Chapter 1

South-Western/Thomson Learning © 2006 - 1

Multinational Corporation (MNC)

Foreign Exchange Markets

Product Markets Subsidiaries InternationalFinancial Markets

DividendRemittance& FinancingExporting

& ImportingInvesting

& Financing

Part IThe International Financial Environment

International Financial Management, 2nd edition

Jeff Madura and Roland FoxISBN 978-1-4080-3229-9 © 2011 Cengage Learn ing EMEA

Cost and Management Accounting: An Introduction, 7th edition

Colin DruryISBN 978-1-40803-213-9 © 2011 Cengage Learn ing EMEA

Chapter 1Multinational Financial

Management: An Overview





Chapter Objectives• To identify the main goal of the

multinational corporation (MNC) andpotential conflicts with that goal;

• To describe the key theories that justifyinternational business; and

• To explain the common methods used toconduct international business.



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South-Western/Thomson Learning © 2006 Page 1 - 3



Impact of Management Control

• The magnitude of agency costs can varywith the management style of the MNC.

• A centralized management style reducesagency costs. However, a decentralizedstyle gives more control to thosemanagers who are closer to thesubsidiary’s operations and environment.



Centralized Multinational Financial Managementfor an MNC with two subsidiaries, A and B

FinancialManagersof Parent

Capital Expendituresat A

Inventory and AccountsReceivable

Management at A

CashManagement

at A

Financing at A

Capital Expendituresat B


Management at B

CashManagement

at B

Financing at B

International Financial Management, 2nd edition, Jeff Madura and Roland FoxISBN 978-1-4080-3229-9 © 2011 Cengage Learn ing EMEA

Decentralized Multinational Financial Management

for an MNC with two subsidiaries, A and B

FinancialManagers

of A

Capital Expendituresat A


Management at A

CashManagement

at A

Financing at A

Capital Expendituresat B


Management at B

CashManagement

at B

Financing at B

FinancialManagers

of B

International Financial Management, 2nd edition, Jeff Madura and Roland FoxISBN 978-1-4080-3229-9 © 2011 Cengage Learn ing EMEA

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Impact of Management Control

• Some MNCs attempt to strike a balance – they allow subsidiary managers to make thekey decisions for their respectiveoperations, but the parent’s managementmonitors the decisions.

• Today, electronic networks make it easierfor the parent to monitor the actions andperformance of its foreign subsidiaries.





Impact of Corporate Control

• Various forms of corporate control canreduce agency costs:

– stock options

– hostile takeover threat

– investor monitoring





Constraints Interfering with the

MNC’s Goal• MNC managers are confronted with various

constraints:

– 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.



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Why are firms motivated to expandtheir business internationally?

Theories of InternationalBusiness (1)

1. Theory of Comparative Advantage

– Specialization by countries can increaseproduction efficiency.

2. Imperfect Markets Theory

– The markets for the various resources used inproduction are “imperfect.”





Why are firms motivated to expand theirbusiness internationally?

Theories of InternationalBusiness (2)

3. Product Cycle Theory

– As a firm matures, it may recognize

additional opportunities outside itshome country.





2. Firm exportsproduct toaccommodateforeign demand

1. Firm createsproduct toaccommodatelocal demand

The International Product Life Cycle

3. Firmestablishesforeignsubsidiary toestablishpresence inforeigncountry andpossibly toreduce costs

4a. Firmdifferentiatesproduct fromcompetitorsand/or expands

product line inforeigncountry

4b. Firm’sforeignbusinessdeclines as itscompetitiveadvantages areeliminated

or



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International BusinessMethods (1)

1. International trade involves exportingand/or importing.

2. Licensing allows a firm to provide itstechnology in exchange for fees or someother benefits.

3. Franchizing obligates a firm to provide aspecialized sales or service strategy,support assistance and possibly an initialinvestment, in exchange for periodic fees.






4. Firms may also penetrate foreign marketsby engaging in a joint venture (jointownership and operation) with firms thatreside in those markets.

5. Acquisitions of existing operations in

foreign countries allow firms to quicklygain control over foreign operations aswell as a share of the foreign market.






6. Firms can also penetrate foreign marketsby establishing new foreign subsidiaries.

• Many MNCs use a combination of methodsto increase international business.

• In general, any method of conductingbusiness that requires a direct investmentin foreign operations is referred to as adirect foreign investment (DFI).



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International Opportunities (1)

• Investment opportunities

– The marginal returns on MNC projects areabove those of purely domestic firms sinceMNCs have expanded opportunity sets ofpossible projects from which to select.

• Financing opportunities

– MNCs can obtain capital funding at a lower costdue to their larger opportunity set of fundingsources around the world.





International Opportunities (2)• 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





International Opportunities (3)• Opportunities in Latin America

– the North American Free Trade Agreement(NAFTA) of 1993

– the removal of investment restrictions

• Opportunities in Asia – the removal of investment restrictions

– the impact of the Asian crisis in 1997–1998



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Exposure to International Risk

• International business usually increasesan MNC’s exposure to:

1. exchange rate movements

2. foreign economies

3. political risk





Overview of an MNC’s CashFlows (1)

Profile A: MNCs Focused on International Trade

U.S.-based

MNC

U.S. Custo mersPayments for products

U.S. BusinessesPayments for supplies

Foreign ImportersPayments for exports

Foreign ExportersPayments for imports





Overview of an MNC’s Cash

Flows (2)Profile B: MNCs Focused on International Trade and

International Arrangements

U.S.-basedMNC

U.S. CustomersPayments for products

U.S. Busin essesPayments for supplies

Foreign ImportersPayments for export s

Foreign ExportersPayments for imports

Foreign FirmsFees for services provided

Fees fo r services received Foreign FirmsInternational Financial Management, 2nd edition


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Overview of an MNC’s Cash Flows (3)Profile C: MNCs Focused on International Trade, International

Arr angem ents , and Direc t For eign Inves tmen t

U.K.-basedMNC

U.K. Customers

Payments for pr oducts

U.K. BusinessesPayments fo r supplies

Foreign ImportersPayments for exports

Foreign ExportersPayments for impo rts

Foreign SubsidiariesFunds remitted back

Foreign FirmsFees for services provided

Fees for services received Foreign Firms

Investment funds Foreign SubsidiariesInternational Financial Management, 2nd edition




n

tt

t

k1=

$,

1

CFE =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(1)

• Domestic Model





n

tt

m

j

t jt j

k1=

1 ,,

1

ERECFE

=Value

E (CF j,t ) = expected cash flows denominated in currency j to bereceived by the U.S. parent at the end of period t

E (ER j,t ) = expected exchange rate at which currency j can beconverted to dollars at the end of period t

k = the weighted average cost of capital of the MNC

Valuation Model for an MNC

(2)• Valuing International Cash Flows



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Impact of Financial Managementand International Conditions on

Value• An MNC will decide how much business toconduct in each country and how muchfinancing to obtain in each currency.

• The MNC’s financial decisions determine itsexposure to the international environment.

• An MNC can control its degree of exposureto exchange rate effects, economic conditions, andpolitical conditions with its financial management.





Organization of the Text

Backgroundon

InternationalFinancialMarkets

(Chapters2–5)

Exchange RateBehavior

(Chapters 6–8)

Long-TermInvestment and

FinancingDecisions

(Chapters 13–18)

Short-TermInvestment and

Financing Decisions(Chapters 19–21)

Exchange RateRisk Management(Chapters 9–12)

Risk andReturn of

MNC

Value andStock Price

of MNC



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