CHAPTER 1

Multinational Financial Management :

An Overview
 After studying this 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 a goal is necessary because all decisions should
contribute to its accomplishment. Thus, if the objective were 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 of goals can always exist – this conflict is referred

to as the agency problem
Constraints 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 its own
environmental constraints. Some countries may enforce
more of these restrictions on a subsidiary whose parent is
based in a different country. Building codes, disposal of
production, 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 severe
pollution problems.
 Regulatory constraints : Each country also enforces its own
regulatory constraints pertaining to taxes, currency convertibility
rules, earnings remittance restrictions, and other regulations that can
affect cash flows of a subsidiary established there.

 
Ethical Constraints : There is no consensus standard of business
conduct that applies to all countries. A business practice that is
perceived unethical in one country 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 to expand their business internationally are (1)
the theory of comparative advantage, (2) the imperfect
markets theory, and (3) the product cycle theory. The three
theories overlap to a degree and can complement each other
in developing a rationale for the evolution of international
business.
Theory of Comparative Advantage
Multinational business has generally increased over time. Part of this
growth is due to the heightened realization that specialization by
countries can increase production efficiency. Some countries, such as
Japan and the United States, have a technology advantage, while other
countries, such as Jamaica, Mexico, and South Africa, have an
advantage in the cost of basic labor. Since these advantages cannot he
easily transported, countries tend to use their advantages to specialize in
the production of goods that can be produced with relative 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 of comparative advantage.
Comparative advantages allow firms to penetrate foreign markets.
Imperfect Markets Theory

Countries differ with respect to resources available for the production

of goods - Yet, even with such comparative advantages, the volume of
international goods would be limited if all resources could be easily
transferred among countries. If markets were perfect, factors of
production would be freely transferable and mobile.
The unrestricted mobility of factors would create 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 of Labor and other
resources used for production.
Product Cycle Theory 

The product cycle theory is a theory made of few steps that follow
each other:
1_ Firm creates to product to accommodate local demand
2_ Firm exports product to accommodate foreign demand
3_ Firm establishes foreign subsidiary to establish presence in
foreign country to minimize cost
4a_ Firm differentiates product from competitors and/or expands
product line in foreign country.
4b_ Firm's Foreign business declines as its competitive advantages
are eliminated
INTERNATIONAL BUSINESS METHODS

Firms use several methods to conduct international

business. The most common methods are these:
 International trade
 Licensing
 Franchising
 Point Ventures
 Acquisitions of existing operations
 Establishing new foreign subsidiaries
International Trade
International trade is a relatively conservative approach that can be used
by firms to penetrate markets (by exporting) or to obtain supplies at a
low cost (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 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. For example, SCB
acquired American Express
Disadvantage : Very high capital needed.
 
Establishing New Foreign Subsidiaries
Firms can also penetrate foreign markets by establishing
new operation subsidiaries to produce and sell their
products. Like a foreign acquisition, this process requires a
large investment.
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, (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. 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 subject to foreign economic conditions. For
example, U.S. firms such as DuPont and Nike experienced
lower-than-expected cash flows because of weak European
economies in the 1992-1993 period and again in the 2000-
2001 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 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 domestic
firm that does not engage in any 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) represents expected cash flows to be received at the end of period t, n
represents 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
Valuing International Cash Flows
An MNC's value can be specified in the samee
manner as a purely domestic organization.
However, consider that the expected cash flows
generated by a parent in the period t may be coming
from various countries which works in different
foreign currencies.