International Managerial Finance

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INTERNATIONAL MANAGERIAL FINANCE

MULTINATIONAL COMPANY

• firm that have international assets and operations in foreign markets and draw part of their total revenue and profits from such markets

What is its primary objective?

• Maximization of the shareholders wealth

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FACTORS THAT INFLUENCE MNC’S

1. Structure• centralized or decentralized

2. Taxes• Variations of tax rates• Accounting for taxable income

3. Financial Market• Borrowings and reserves

4. Currency5. Language

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REASONS FOR INTERNATIONAL EXPANSION

1. Theory of Comparative Advantage• Specialization by countries can increase

production efficiency2. Imperfect Market Theory• The markets for the various resources used

in production are imperfect3. Production Theory• Firms may recognize additional

opportunities outside its home country

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OTHER REASONS• To seek new markets.• To seek raw materials.• To seek new technology.• To seek production efficiency.

• To diversify.

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INTERNATIONAL BUSINESS MODELS

1. International Trade (Export/Import)2. Licensing• involves selling copyrights, patents, trademarks or legal rights in

exchange for fees known as royalties3. Franchising• agreement to provides a specialized sales or service strategy, support

assistance in exchange for periodic fees.4. Joint Venture• a venture that is owned and operated by two or more firms.

5. Acquisitions• allow firms to have full control over their foreign businesses and to

quickly obtain a large portion of foreign market share.6. Direct Foreign Investment (DFI)

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FINANCIAL STATEMENTS

Purely domestic vs. International

• Consolidation• Translation of individual accounts• Overall reporting of international profits

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CONSOLIDATION

• Consolidation of financial statements of subsidiaries according to the percentage of ownership by the parent company

• One-line income-item reporting• Full consolidation

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TRANSLATION OF INDIVIDUAL ACCOUNTS

Under FASB No. 52,the current-rate method is implemented in a two-step process.

• Current-rate method The method by which the functional-currency-denominated financial statements of an MNC’s subsidiary are translated into the parent company’s currency.

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1st step — Foreign-currency elements are translated by each subsidiary into the functional currency.

2nd step — The functional-currency-denominated financial statements of the foreign subsidiary are translated into the parent’s currency

Functional currency —the currency of the host country in which a subsidiary primarily generate


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• The first step can lead to transaction (cash) gains or losses. Whether realized or not, these gains or losses are charged directly to current income.

• The completion of the second step can result in translation (accounting) adjustments, which are excluded from current income. Instead, they are disclosed and charged to a separate component of stockholders’ equity.


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INTERNATIONAL PROFITS

• Before January 1976 — multinationals utilize a special account called the reserve account to show “smooth” international profits.

• Excess international profits due to favorable exchange fluctuations were deposited in this account.

• Withdrawals were made during periods of high losses stemming from unfavorable exchange movements.

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• Between 1976 and 1982 — Both transaction gains or losses and translation adjustments be included in net income, with separate disclosure of only the aggregate foreign exchange gain or loss.

• Since the issuance of FASB No. 52, only certain transactional gains or losses are reflected in the income statement.

INTERNATIONAL PROFITS

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RISKS THAT AFFECT MULTINATIONAL

COMPANIES

• Foreign Exchange Risk- The risk of an investment's value changing due

to changing currency exchange rates.

Companies manage FX risk by: - hedging - use of clauses in contracts - production outsourcing

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• Political Risk- This is the risk of loss (or gain) from unforeseen

government actions or other effects of a political character such as acts terrorism to outright expropriation of assets held by foreigners.

Companies manage political risk by:- insuring the company- having control procedures- dealing with it on an ongoing basis- diversification

RISKS THAT AFFECT MULTINATIONAL

COMPANIES

LONG-TERM INVESTMENT ANDFINANCING DECISIONS

IMPORTANT LONG-TERM ASPECTS:

1. FOREIGN DIRECT INVESTMENT• Parent company (home country) TRANSFERS CAPITAL,

MANAGERIAL, and ENTREPRENEURIAL assets to the subsidiary (host country)

• Law of Host Country e.g. RECIPROCITY, PAID-IN CAPITAL $200,000 (peso

equivalent)

2. INVESTMENT CASH FLOW AND DECISION • Measurement

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IMPORTANT LONG-TERM ASPECTS: MV of parent or host country?

• Taxes 30 % of Net Income

• Parent vs. Project Cash Flow Cash flows from the project may differ from those remitted to

the parent Policy

• Adjusting to Risks Adjust expected cash flows to reflect the risks e.g. Political Risk

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IMPORTANT LONG-TERM ASPECTS:

3. CAPITAL STRUCTURE • Unlike domestic firms, have access to a wider variety of

financial instruments• Same options of raising capital

Debt and Equity Financing• Different currencies, different capital structure for each

multinational

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LONG-TERM INVESTMENT AND FINANCING DECISIONS

4. LONG-TERM DEBT• International Bonds:

Foreign Bond – an international bond that is sold in the country in which it is denominatedEurobond –an international bond that is sold in countries other than the country in which it is denominated

5. EQUITY CAPITAL • Sell shares in international capital markets• Use Joint Ventures

less than 50%, not full ownership Use little equity; borrow from the host country

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SHORT TERM FINANCIAL DECISIONS

Euromarket• Eurobond market

-offers nondomestic long-term financing oppurtunities

• Eurocurrency market-provides short-term, foreign-currency

financing

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Example:

A multinational plastics company, International Molding, has subsidiaries in Switzerland (local currency, Swiss franc, Sf) and Japan (local currency, Japanese yen, ¥). On the basis of each subsidiary’s forecast operations, the short-term financial needs (in equivalent U.S. dollars) are as follows:

•Switzerland: $80 million excess cash to be invested (lent)•Japan: $60 million funds to be raised (borrowed)

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Example:

US$ Sf ¥Spot exchange rates Sf 1.27/US$ ¥ 108.37/US$Forecast percent change -2.00% -1.00%Interest rates

NominalEuromarket 3.30% 4.10% 1.50%Domestic 3.00% 3.80% 1.70%

EffectiveEuromarket 3.30% 2.01% 2.51%Domestic 3.00% 1.72% 2.71%

ItemCurrency

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CASH MANAGEMENT

Foreign Exchange Exposures• Accounting Exposures– By protecting its undesirable cash and marketable

securities exposures (hedging strategies)• Economic Exposures– By making certain adjustments in its operations

Hedging Strategies

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ADJUSTMENTS IN OPERATIONS

Two Routes:1. Third parties2. Within the Multinational Company– In appreciation-prone countries, intra-MNC A/R are

collected as soon as possible while intra-MNC A/P are delayed as long as possible

– In depreciation-prone countries, intra-MNC A/R are collected as late as possible while intra-MNC A/P are paid as soon as possible

*also known as “leading and lagging” or “leads and lags”

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CREDITAND INVENTORY MANAGEMENT

• Credit management–Government support

• Inventory management– Various warehouse locations– Government intervention (wars,

expropriations, blockages, etc)– Other factors (exchange rate fluctuations,

tariffs, integration schemes, etc)

MERGER AND JOINT VENTURE

• As previously defined, merger is when the acquirer company and its target company ceased to operate for the existence of a newly formed company.

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• JOINT VENTURE– An association of two or more individuals

or entities for the purpose of engaging in a specific business enterprise for profit.

– parties enter into joint venture contracts or agreement in order to combine strengths and increase advantage while minimizing risk.

MERGER AND JOINT VENTURE

DIFFERENCES BETWEEN MERGER AND JOINT VENTURE

• Legal Structure– In mergers, the two transacting

companies ceased to operate and a new company is formed. While in joint venture, the entities may opt to form a new company but this is not a mean for the company to cease to operate.

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• OWNERSHIP– In merger, owners of the newly formed

company are the same as owners of original companies. While in joint venture, the owners of the newly formed company are the separate entities forming them.

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• Scope– A merger is useful when two companies wish to

be fully integrated – that is, when two firms have enough overlap they can perform most of their business together. A joint venture, on the other hand, typically has a much more limited scope. A joint venture normally focuses on a specific area (Assets or Operations) where two firms overlap and can work together but business as a whole remains separated.

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EXAMPLES: MERGER

• DISNEY – PIXAR• Sirius/XM Radio• Exxon-Mobil• New York Central and Pennsylvania

Railroad• Daimler Benz - Chrysler

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EXAMPLES: JOINT VENTURE

• Shell-MS and BP• United Glass (Owens-Illinois and Distillers)• British Aircraft (GEC and Vickers)• Mitsubishi Heavy Industries and Chrysler• Kellogg Company and Wilmar International• Hulu (NBC Universal Television Group, Fox

Broadcasting Company and Disney – ABC Television Group)

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International Managerial Finance

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