Daniels19 Multinational Finance

19-1Copyright © 2009 Pearson Education, Inc. publishing as Prentice Hall

Part Six Managing International Operations

Chapter Nineteen

The Multinational Finance Function


Chapter Objectives

• To describe the multinational finance function and how it fits in the MNE’s organizational structure

• To show how companies can acquire outside funds for normal operations and expansion, including offshore debt and equity funds

• To explore how offshore financial centers are used to raise funds and manage cash flows

• To explain how companies include international factors in the capital budgeting process

• To discuss the major internal sources of funds available to the MNE and to show how these funds are managed globally

• To describe how companies protect against the major financial risks of inflation and exchange-rate movements


Factors Influencing Finance in International Business


The Role of the Treasurer in the Financial Function


The Finance Function

• The corporate finance function acquires and allocates financial resources among the company’s activities and projects. Four key functions are: Capital structure. Long-term financing. Capital budgeting. Working capital management.

• The CFO acquires financial resources and allocates them among the company’s activities and projects.


Capital Structure

• Capital structure of the company is the mix between long-term debt and equity

• Leverage is the degree to which a firm funds the growth of business by debt.

• The amount of leverage used varies from country to country.


Factors that Influence the Choice of Capital Structure

• Choice of capital structure depends on: tax rates degree of development of local equity markets creditor rights

• Companies can use local and international debt markets to raise funds.


Global Capital Markets

• Two major sources of funds external to the MNE’s normal operations are debt markets and equity markets.


Eurocurrencies

• A Eurocurrency is any currency banked outside its country of origin, but it is primarily dollars banked outside the United States

• Four major sources of Eurocurrencies: Foreign governments or individuals who want to hold

dollars outside the United States Multinational enterprises that have cash in excess of

current needs European banks with foreign currency in excess of

current needs Countries such as Germany, Japan, and Taiwan that

have large balance-of-trade surpluses held as reserves


International Bonds

• A foreign bond is one sold outside the country of the borrower but denominated in the currency of the country of issue

• A Eurobond, also called a global bond, is a bond issue sold in a currency other than that of the country of issue


Equity Securities and the Euroequity Market

• The three largest stock markets in the world are in New York, Tokyo, and London, with the U.S. markets controlling nearly half of the world’s stock market capitalization.

• Euroequities are shares listed on stock exchanges in countries other than the home country of the issuing company


American Depositary Receipts (ADRs)

• Most foreign companies that list on the U.S. stock exchanges do so through American Depositary Receipts, which are financial documents that represent a share or part of a share of stock in the foreign company

• ADRs are easier to trade on the U.S. exchanges than are foreign shares


Offshore Financial Centers

• Offshore financing is the provision of financial services by banks and other agents to nonresidents.

• Offshore financial centers are cities or countries that provide large amounts of funds in currencies other than their own.

• OFCs offer low or zero taxation, moderate or light financial regulation, and banking secrecy and anonymity.

• The OECD is trying to eliminate the harmful tax practices in tax-haven countries.


Capital Budgeting in a Global Context

• Capital budgeting is the process whereby MNEs determine which projects and countries will receive capital investment funds.


Methods Of Capital Budgeting

• Capital budgeting techniques: Payback period. Net present value of a project. Internal rate of return.

• MNEs need to determine free cash flows based on cash flow estimates and tax rates in different countries and an appropriate required rate of return adjusted for risk.

• Two ways to deal with the variations in future cash flows: determine several different scenarios or adjust the hurdle rate


Internal Sources of Funds

• Funds are working capital, or current assets minus current liabilities.

• Sources of internal funds are: Loans. Investments through equity capital. Intercompany receivables and payables. Dividends.


How the MNE Handles Its Funds (I): Internal Funds


Global Cash Management

• Cash budgets and forecasts are essential in assessing a company’s cash needs.

• Dividends are a good source of intercompany transfers, but governments often restrict their free movement.

• Multilateral netting is the process of coordinating cash inflows and outflows among subsidiaries so that only net cash is transferred, reducing transaction costs.

• Netting requires sophisticated software and good banking relationships in different countries.


How the MNE Handles Its Funds (II): Multilateral Cash Flows


How the MNE Handles Its Funds (IV):Multilateral Netting


Foreign-Exchange Risk Management

• Translation exposure arises because the dollar value of the exposed asset or liability changes as the exchange rate changes.

• Transaction exposure arises because the receivable or payable changes in value as the exchange rate changes.

• Economic, or operating, exposure arises from effects of exchange-rate changes on: Future cash flows. The sourcing of parts and components. The location of investments. The competitive position of the company in different markets.


Exposure-Management Strategy

• To protect assets from exchange-rate risk, management needs to: Define and measure exposure. Establish a reporting system. Adopt an overall policy on exposure

management. Formulate hedging strategies.


Formulating Hedging Strategies

• Hedging strategies can be operational or financial.

• Operational strategies include: Using local debt to balance local assets. Taking advantage of leads and lags for intercompany

payments.• Forward contracts can establish a fixed

exchange rate for future transactions.• Currency options can ensure access to foreign

currency at a fixed exchange rate for a specific period of time.


Taxation of Foreign Source Income

• Tax planning influences profitability and cash flow.• Taxation has a strong impact on several choices:

Location of operations Choice of operating form, such as export or import, licensing

agreement, overseas investment Legal form of the new enterprise, such as branch or subsidiary Possible facilities in tax-haven countries to raise capital and

manage cash Method of financing, such as internal or external sourcing and

debt or equity Capital budgeting decisions Method of setting transfer prices


International Tax Practices

• Problems with different countries’ tax practices arise from: Lack of familiarity with laws. Loose enforcement.

• With a value-added tax, each company pays a percentage of the value added to a product at each stage of the business process.

• Corporate tax rates vary from country to country.


Approaches to Corporate Taxation

• In the separate entity approach, governments tax each taxable entity when it earns income.

• An integrated system tries to avoid double taxation of corporate income through split tax rates or tax credits.


Taxing Branches And Subsidiaries

• Foreign branch income (or loss) is directly included in the parent’s taxable income.

• Tax deferral means that income from a subsidiary is not taxed until it is remitted to the parent company as a dividend.

• In a CFC, U.S. shareholders hold more than 50 percent of the voting stock.

• Active income is derived from the direct conduct of a trade or business. Passive income (also called Subpart F income) usually is derived from operations in a tax-haven country.


The Tax-Haven Subsidiary as Holding Company


The Tax Status of U.S.-Owned Foreign Subsidiaries


Transfer Prices

• A transfer price is a price on goods and services one member of a corporate family sells to another.

• The OECD has set transfer pricing guidelines to eliminate the manipulation of prices and, therefore, taxes for MNEs.


Double Taxation and Tax Credit

• The IRS allows a tax credit for corporate income tax U.S. companies pay to another country. A tax credit is a dollar-for-dollar reduction of tax liability and must coincide with the recognition of income.

• The purpose of tax treaties is to prevent double taxation or to provide remedies when it occurs.

Daniels19 Multinational Finance

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