CHAPTER 1
Multinational Financial Management : An Overview
After studying this chapter, chapter, you should be able to: > Identify the main goal of the MNC and potential conflicts with that goal > Describe the key theories that justify international business > Explain the common methods used to conduct international business
Goal
of the MNC
The commonly accepted goal of an MNC is to maximize shareholder wealth. Developing Developing a goal is necessary necessar y because all decisions should contribute to to its accomplishment. Thus, if the objective were to to maximize earnings in the near future, rather than to maximize shareholder wealth, the firm·s policies would be different.
Conflicts with the MNC
Goal
It has often been argued that managers of a firm may make decisions that conflict with the firm·s goal to maximize shareholder wealth. For example, a decision to establish a subsidiary in one location for the appeal. A conflict conflict of goals can always always exist exist ² this conflict conflict is referred to to as a s the agency a gency problem
Constraints Interfering Interfering with the MNC's Goal
When financial managers of MNCs attempt to maximize their firm's value, they are confronted with various constraints that can be classified as environmental, regulatory, or ethical in nature
Environmental constraints : Each country enforces Environmental enforces its own environmental envir onmental constraints. Some countries may enfor e nforce ce more of these restrictions on a subsidiary subsidiar y whose parent is based in a different dif ferent country. Building Building codes, disposal of production, waste waste materials, and pollution controls are examples of restrictions that force subsidiaries to incur additional costs. Many European countries have recently imposed rougher antipollution laws as a result of sev severe ere pollution problems.
Regulatory Regulat ory constraints constraints : Each country country also enforce enforces s its own regulatory constraints pertaining per taining to taxes, currency conver convertibility tibility rules, earnings remittance restrictions, and other regulations that can affect cash flows of a subsidiary established there.
Ethical Constraints Ethical Constraints : There is no consensus standar standard d of business conduct that applies to all countries. A business practice that is perceived perceiv ed unethical in one country countr y may be totally ethical in another. Example : Bribes, Sexual products in Arab countries.
Theories of International Business The commonly held theories as to why firms become motivated motivat ed to expand their business internationally are (1) the theory of comparative advantage, (2) the imperfect markets theory, theory, and (3) ( 3) the product cycle theory. The three theories overlap to a degree and can complement co mplement each other in dev developing eloping a rationale ra tionale for the evolution of international business.
Theory of Comparative Advantage Multinational business has generally increased over over time. Part of this growth is due to the heightened realization realization that specialization by countries can increase production efficiency. eff iciency. Some countries, such as Japan and the United States, have a technology advantage, while while other countries, such as Jamaica, Mexico, and South Africa, have an advantage in the cost of basic labor labor.. Since these advantages cannot he easily transported, transpor ted, countries tend tend to use u se their advantages to specialize in the production of goods that can be produced with relative efficiency. efficiency. This explains why countries such as Japan and the United States are large producers of computer components, while countries such as Jamaica and Mexico are large producers of agricultural and handmade goods. Specialization in some products may result in no production of other products, so that trade between countries is essential. This is the argument made by the classical theory theor y of comparative advantage. Comparative advantages allow firms to penetrate foreign foreign markets. m arkets.
Imperfect Markets Markets Theory Theor y Countries differ with respect to resources available available for the production of goods - Yet, even even with such comparative advantages, the volume of international goods would be limited if all a ll resources could be easily transferred among countries. If markets were perfect, factors of production would be freely transferable and mobile. The unrestricted mobility mobility of factors would create equality equality in costs and would remove the comparative advantage. However, the real world suffers from imperfect market conditions where factors of production are somewhat immobile. There are costs and often restrictions related to the transfer transfer of Labor and other resources used for production.
Product Cycle Theory The product cycle theory is a theory theor y made of few steps steps that follow each other: 1_ Firm creates to product to accommodate local demand 2_ Firm exports expor ts product to accommodate foreign demand 3_ Firm establishes foreign subsidiary to establish esta blish presence in foreign country to minimize cost 4a_ Firm differentiat dif ferentiates es product from competitors and/or expands product product line in foreign country. 4b_ Firm's Foreign business declines as its competitiv competitive e advantages are eliminated
INTERNATIONAL INTERNA TIONAL BUSINESS METHODS Firms use several methods to conduct international business. The most common methods are these: ´
International trade
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Licensing
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Franchising
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Point Ventures
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Acquisitions of existing operations
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Establishing new foreign subsidiaries
International Trade International trade is a relatively conservative conser vative approach approach that can be used by firms to penetrate pen etrate markets markets (by exporting) or to obtain supplies at a low cost (importing). ( importing). This approach entails minimal risk because the firm does not place of its capital at risk. If the firm experiences a decline in its exporting or importing impor ting it can normally reduce or discontinue this part of its business at a low cost. Licensing Licensing obligates a firm to provide its technology (copyrights, patents, trademarks, or trade names in exchange for fees or some other specified benefits. A good point about Licensing is that no exporting and transferring costs are required but as a disadvantage, the company can not assure quality control.
Franchising Franchising obligates a firm to provide a specialized sales or service strategy, support assistance, and possibly an initial investment in the franchise in exchange for periodic fees Joint venture A joint venture is a venture that is operated by two or more firms. Example Fuji & Xerox.
Acquisitions of Existing Operations Firms frequently acquire other firms in foreign countries as a means of penetrating foreign markets. markets. For example, SCB acquired American Express Disadvantage : Very Very high capital needed. Establishing New Foreign Subsidiaries Firms can also penetrate foreign markets markets by establishing new operation subsidiaries to produce and sell their products. Like Like a foreign acquisition, this process requires a large inv investment. estment.
EXPOSURE TO INTERNATIONAL RISK Although international business can reduce an MNC's exposure to its country's economic conditions, it usually increases an MNC's exposure to exchange rate movements, movements, (2) foreign economic conditions, and (3) political changes.
Exposure to Exchange Rate Movements Most international business results in the exchange of one currency for another to make payment. Since exchange rates fluctuate over time, the cash outflows required to make payments change accordingly a ccordingly.. Consequently, the number of units of home currency needed to purchase foreign supplies can change even if the suppliers have not adjusted their prices.
Exposure to Foreign Economies When MNCs enter foreign markets to sell products, the demand for these products is dependent on the economic conditions in those markets. Thus, the cash flows of the MNC are a re subject to foreign economic conditions. For example, example, U.S. firms such as DuPont and Nike experienced lower-than-expected lower-than-expected cash flows because of weak European economies in the 1992-19 1992-1993 93 period and again in the 2000-200 2000-2001 1 period.
Exposure to Political Risk When MNCs establish subsidiaries in foreign countries, they become exposed to political risk, which arises because the host government or the public may take actions that affect the MNC's cash flows. For example, the host government may impose higher taxes on U.S.-based subsidiaries in retaliation for actions by the U.S government. Exp. Terrorism
Overview of an MNC CASHFLOW
Valuation Model For An MNC The Value of an MNC is relevant to to its shareholders and its debtholders. When managers make decisions that maximize the value of the firm, they maximize shareholder wealth. There are many models for valuing an MNC.
Domestic Model Before modeling an MNC's value, we should consider the valuation of a purely Before domestic firm that does not engage in any foreign foreign transactions. The value (V) of a purely domestic Firm in the United States is commonly specified as the present value of its expected cash flows, where the discount rate used reflects the weighted cost of capital and represents the required rate of return by investors:
Where E(CF$,t) E(CF$,t ) represents expected cash flows to be received at the end of period t, n represents represe nts the number of periods into the future in which cash flows are received, and k represents the required rate of return by investors. The dollar cash flows in period t represent funds received by the firm minus funds needed to pay expenses or taxes, or to reinvest in the firm (such as an investment to replace old computers or machinery). The expected cash flows are estimated from knowledge about various existing projects as well as other projects that will be implemented in the future. A firm's decisions about how it should invest Funds to expand its business can affect its future cash flows and therefore therefore can affect the firm's value.
Valuing International Cash Flows An MNC's value can be specified in the samee manner as a purely domestic organization. organization. However Howe ver,, consider that the t he expected cash flows generated by a parent in the period t may be coming from various countries which works in different foreign currencies.
