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ch20

Student: ___________________________________________________________________________

1.

Investment decisions, in international business, are decisions about how to finance a firm's activities. True False

2.

In international business, money management decisions are decisions about how to manage the firm's financial resources most efficiently. True False

3.

Capital budgeting quantifies the benefits, costs, and risks of an investment. True False

4.

A firm's cash flows will be negative at first. True False

5.

If the net present value of the discounted cash flows is slightly less than zero, the firm should go ahead with the project. True False

6.

The problem of blocked earnings is much more serious than it was previously. True False

7.

When using capital budgeting techniques to evaluate a potential foreign project, cash flows to the project and cash flows to the parent must be considered as one. True False

8.

Stockholders perceive blocked earnings as contributing to the value of the firm. True False

9.

In recent decades, the risk of outright expropriations has increased. True False

10. Political risk assessment is more art than science. True False

11. In practice, the biggest problem arising from economic mismanagement has been rising interest rates. True False

12. Empirical studies show that there is a long-run relationship between a country's relative inflation rates and changes in exchange rates. True False

13. Adjusting discount rates to reflect a location's riskiness is a rare practice. True False

14. The cost of capital is typically higher in the global capital market, by virtue of its size and liquidity, than in many domestic capital markets. True False

15. The amount of local currency required to meet interest payments and retire principal on local debt obligations is not affected when a country's currency depreciates. True False

16. Different tax regimes can determine the relative attractiveness of debt and equity in a country. True False

17. Efficient money management involves minimizing cash balances and reducing transaction costs. True False

18. Money market accounts typically offer a relatively high rate of interest. True False

19. Transaction costs arise when cash moves from one location to another. True False

20. Many nations follow the worldwide principle that they have the right to tax income earned outside their boundaries by entities based in their country. True False

21. Double taxation is mitigated to some extent by tax credits, tax treaties, and the deferral principle. True False

22. A deferral principle specifies that parent companies are not taxed on foreign source income until they actually receive a dividend. True False

23. International businesses avoid or defer income taxes by establishing a wholly owned, nonoperating subsidiary in the tax haven. True False

24. U.S. regulations tax U.S. shareholders on the firm's overseas income when it is earned, regardless of when the parent company in the United States receives it. True False

25. The practice of unbundling refers solely to the use of royalty payments and fees to transfer liquid funds across borders. True False

26. Fronting loans is the most common method by which firms transfer funds from foreign subsidiaries to the parent company. True False

27. Fees are usually levied as a percentage of a subsidiary's gross revenues. True False

28. Most governments are in favor of transfer pricing. True False

29. Dividends have certain tax advantages over royalties and fees, particularly when the corporate tax rate is higher in the host country than in the parent's home country. True False

30. Transfer pricing is consistent with a policy of treating each subsidiary in the firm as a profit center. True False

31. The correct transfer price, according to the IRS guidelines, is an arm's-length price. True False

32. In a fronting loan, the parent company lends cash directly to the foreign subsidiary, and the subsidiary repays it later. True False

33. Fronting loans can circumvent host country restrictions on the remittance of funds from a foreign subsidiary to the parent company. True False

34. A fronting loan does not provide any tax advantage. True False

35. Cash balances are typically deposited in liquid accounts. True False

36. By pooling its cash reserves, a firm can reduce the total size of the cash pool it must hold in highly liquid accounts. True False

37. Cash needs are assumed to be normally distributed in each country and independent of each other. True False

38. Many firms hold at least their subsidiaries' precautionary cash reserves at a centralized depository, having each subsidiary hold its own day-to-day-needs cash balance. True False

39. Multilateral netting compounds the transaction costs that arise when many transactions occur between a firm and its subsidiaries. True False

40. Multilateral netting is an extension of bilateral netting. True False

41. In international business, decisions about what activities to finance are best known as: A. B. C. D. investment decisions. financing decisions. money management decisions. economic decisions.

42. Theses are decisions about how to manage the firm's financial resources most efficiently. A. B. C. D. Investment decisions Financing decisions Money management decisions Economic decisions

43. In international business, financing decisions are: A. B. C. D. decisions about what activities to finance. decisions about how to finance a firms activities. decisions about how to manage the firm's financial resources most efficiently. decisions about the operational activities of a firm.

44. Good financial management can help a firm in all of the following ways, except: A. B. C. D. reduce the costs of creating value. add value by improving customer service. reduce the firm's cost of capital. totally eliminate the firm's tax burden.

45. _____ can help financial managers in an international business to quantify the various benefits, costs, and risks that are likely to flow from an investment in a given location. A. B. C. D. Operational techniques Capital budgeting techniques Socio-economic techniques Production techniques

46. Capital budgeting: A. in practice is a very simple and perfect process. B. techniques are not useful for quantifying the benefits, costs, and risks of an investment. C. for a foreign project uses the same theoretical framework that domestic capital budgeting uses. D techniques, for evaluating potential foreign projects, do not require the firm to recognize the specific . risks arising from its foreign location. 47. Which of the following statements is true regarding cash flows that a firm must estimate to decide if it should go ahead with a project? A. In most cases, the cash flows will be positive at first, because the firm is yet to invest heavily in production facilities. B. After some initial period the cash flows becomes negative as investment costs increase and revenues stabilize. C Once the cash flows have been estimated, they must be discounted to determine their net present value . using an appropriate discount rate. D. If the net present value of the discounted cash flows is less than zero, the firm should go ahead with the project. 48. All of the following are factors complicating the capital budgeting process for an international business except: A. a distinction must be made between cash flows to the project and cash flows to the parent company. B cash flows to the project and to the parent company will be the same when a host-country government . blocks the repatriation of cash flows from a foreign investment. C. political and economic risks, including foreign exchange risk, can significantly change the value of a foreign investment. D. the connection between cash flows to the parent and the source of financing must be recognized. 49. Restrictions on a project, because of which a firm may not be able to remit all its cash flows to the parent company: A. do not affect the net present value of the project to the parent company. B. do not affect the net present value of the project itself. C. do not limit the cash flows of the parent company in any manner. D. establishes the fact that a foreign project need not be analyzed from the perspective of the parent company.

50. Which of the following statements is true about government restrictions that block earnings from a foreign project? A. The problem of blocked earnings is now much more serious than before. B Greater acceptance of free market economics has increased the number of countries in which . governments are likely to block earnings. C. Firms have few options for circumventing host-government attempts to block the free flow of funds from an affiliate. D. Stockholders do not perceive blocked earnings as contributing to the value of the firm. 51. Identify the incorrect statement regarding political risk. A It can be defined it as the likelihood that political forces will cause drastic changes in a country's business . environment that hurt the profit and other goals of a business. B. It tends to be greater in countries where the underlying nature of the society makes the likelihood of social unrest high. C When political risk is high, there is a high probability that a change will occur in the country's political . environment that will endanger foreign firms there. D. In most cases, political change may result in the expropriation of foreign firms' assets. 52. Political risk assessment: A. B. C. D. is without value. is more science than art. tries to predict a future that can only be guessed. usually makes correct future predictions.

53. Historically, many governments have expanded their domestic money supply in misguided attempts to stimulate economic activity. The result has often been: A. B. C. D. price inflation. low interest rates. a strong local currency. private sector growth.

54. The relationship between a country's relative inflation rates and changes in exchange rates is: A. B. C. D. much closer than what theory would predict. not reliable in the short run. totally reliable in the long run. according to empirical studies, non existent in the long run.

55. Adjusting discount rates to reflect a location's riskiness: A. B. C. D. is not widely practiced by firms. treats all risk as a single problem. penalizes distant cash flows too heavily. does not penalize early cash flows enough.

56. One method of analyzing a foreign investment opportunity is to treat all risk as a single problem by adjusting the discount rate applicable. For countries with significant political and economic risks, the: A. B. C. D. discount rates are revised upward. discount rates are revised downward. early cash flows are not adjusted. distant cash flows are heavily penalized.

57. For firm's seeking external financing for a project, the cost of capital is typically lower in: A. B. C. D. global capital markets. domestic capital markets. small markets. relatively illiquid markets.

58. In capital budgeting decisions, the discount rate must be adjusted downward: A. B. C. D. in countries where liquidity is limited. when the cost of capital used to finance a project is high. in countries where governments offer foreign firms low-interest loans. in countries where the perceived political and economic risks are greater.

59. If foreign debt obligation must be served, the amount of local currency required to do this will: A. B. C. D. increase as the currency depreciates, and this effectively raises the cost of capital. decrease as the currency depreciates, and this effectively decreases the cost of capital. increase as the currency appreciates, and this effectively raises the cost of capital. increase as the currency appreciates, and this effectively decreases the cost of capital.

60. Identify the correct statement pertaining to financial structures. A. The financial structures of firms are remarkably similar across countries. B. It can be described as the mix of debt and equity used to finance a business. C. If interest income were taxed at a high rate, a preference for equity financing over debt financing would be expected. D According to empirical research, country differences in financial structure are systematically related to . country differences in tax structure. 61. It is best recommended that an international business adopt a financial structure: A. B. C. D. that is consistent with host-country norms. that is insensitive to the local monetary policy. that minimizes the cost of capital. that allows it to easily evaluate its return on equity relative to local competitors in the same industry.

62. If a firm invests its cash balances in money market accounts: A. B. C. D. it will have unlimited liquidity and earn a high rate of interest. it will have unlimited liquidity but will earn a relatively low rate of interest. it will have limited liquidity but will earn a high rate of interest. it will have limited liquidity but will earn a low rate of interest.

63. The commission fee a firm pays to foreign exchange dealers for changing cash from one currency into another currency is known as: A. B. C. D. foreign exchange tax. transfer fee. transaction cost. conversion tax.

64. These are the charges that most banks take for moving cash from one location to another. A. B. C. D. Currency taxes Location fee Exchange charges Transfer fee

65. This occurs when both the host-country government and the parent company's home government tax the income of a foreign subsidiary. A. B. C. D. Double taxation Tax duplication Tax discrepancy Indirect taxation

66. A _____ allows an entity to reduce the taxes paid to the home government by the amount of taxes paid to the foreign government. A. B. C. D. tax treaty tax credit deferral principle tax benefit

67. A tax treaty: A. allows an entity to reduce the taxes paid to the home government by the amount of taxes paid to the foreign government. B. directs both the host-country government and the parent company's home government to tax the income of a foreign subsidiary. C is an agreement between two countries specifying what items of income will be taxed by the authorities . of the country where the income is earned. D. specifies that parent companies are not taxed on foreign source income until they actually receive a dividend. 68. A tax haven: A. allows an entity to reduce the taxes paid to the home government and those paid to foreign governments. B.directs both the host-country government and the parent company's home government not to tax the income of a foreign subsidiary. C. specifies that parent companies are not taxed on foreign source income until they actually receive a dividend. D. is a country with an exceptionally low, or even no, income tax.

69. By using a mix of techniques to transfer liquid funds from a foreign subsidiary to the parent company, _____ allow(s) an international business to recover funds from its foreign subsidiaries without piquing host-country sensitivities with large "dividend drains." A. B. C. D. unbundling tax treaties the deferral principle tax havens

70. The payment of dividends is an attractive option: A. B. C. D. when the rate of tax levied on dividends by the host-country government is high. for subsidiaries based in "high-risk" countries. for newly established subsidiaries. when local equity participation is limited.

71. Which of the following represents the remuneration paid to the owners of technology, patents, or trade names for the use of that technology or the right to manufacture and/or sell products under those patents or trade names? A. B. C. D. Trademarks Royalties Copyrights Transfer fees

72. Which of the following statements is true regarding royalties and fees? A. Royalties may be levied as fixed charges for the particular services provided. B A fee may be levied as a fixed monetary amount per unit of the product the subsidiary sells or as a . percentage of a subsidiary's gross revenues. C Royalties may be differentiated into "management royalties" for general expertise and advice . and "technical assistance royalties" for guidance in technical matters. D Royalties and fees are often tax-deductible locally, so arranging for payment in royalties and fees will . reduce a foreign subsidiary's tax liability. 73. The price at which goods and services are transferred between entities within the firm is referred to as: A. B. C. D. transfer tax. service tax. service charges. transfer price.

74. All of the following are gains that can be derived by manipulating transfer prices, except: A. a firm can reduce its tax liabilities by shifting earnings from a high-tax country to a low-tax one. B a firm can move funds out of a country where a significant currency devaluation is expected, thereby . reducing its exposure to foreign exchange risk. C funds can be moved by a firm from a subsidiary to the parent company when financial transfers in the . form of dividends are blocked by host-country government policies. D if there are high transfer prices on goods or services being imported into the country, a firm can reduce . the import duties it must pay when an ad valorem tariff is in force.

75. Which of the following statements is true regarding transfer pricing? A. Most governments favor the use of transfer pricing. B The correct transfer price, according to the IRS guidelines, is an arm's-length pricethe price that would . prevail between unrelated firms in a market setting. C. Transfer pricing is consistent with a policy of treating each subsidiary in the firm as a profit center. D. The opportunity for price manipulation is much greater with arm's-length pricing than it is for cost-based transfer pricing. 76. This is a loan between a parent and its subsidiary channeled through a financial intermediary, usually a large international bank. A. B. C. D. International loan Fronting loan Transfer loan Unbundling loan

77. A fronting loan: A helps a multinational to make a direct intrafirm loan, where the parent company lends cash directly to the . foreign subsidiary, and the subsidiary repays it later. B. can circumvent host-country restrictions on the remittance of funds from a foreign subsidiary to the parent company. C. is suitable for lending funds to subsidiaries based in countries which are politically stable. D. offers insignificant tax advantages. 78. In general, firms prefer to hold cash balances at a centralized depository for all of the following reasons except: A. by pooling cash reserves centrally, the firm can deposit larger amounts. B it enables the firm to invest a larger amount of cash reserves in short-term, highly liquid financial . instruments that earn a lower interest rate. Cif the centralized depository is located in a major financial center, it has access to information about good . short-term investment opportunities that the typical foreign subsidiary would lack. D. the firm can reduce the total size of the cash pool it must hold in highly liquid accounts. 79. A French subsidiary owes a Mexican subsidiary $6 million and the Mexican subsidiary simultaneously owes the French subsidiary $4 million. Through a mutual settlement a single payment of $2 million is made from the French subsidiary to the Mexican subsidiary, the remaining debt being canceled. This example best exemplifies: A. B. C. D. bilateral netting. a transfer loan. multilateral netting. a fronting loan.

80. Which of the following allows a multinational firm to reduce the transaction costs that arise when many transactions occur between its subsidiaries? A. B. C. D. Unbundling Deferral principle Fronting loan Multilateral netting

81. Identify the main sets of related decisions included within the scope of financial management in the international business.

82. What is the role of investment, financing, and money management decisions in an international business?

83. What is capital budgeting?

84. What are the factors complicating the process of capital budgeting for an international business?

85. Should a foreign project be analyzed from the perspective of the parent company?

86. What are political risks? Why must a company evaluating foreign investment opportunities consider the political risks that stem from the foreign location?

87. What is economic risk? How does it affect international businesses?

88. In analyzing a foreign investment opportunity, how can the additional risk that stems from its location be handled?

89. What are the factors a firm considers when seeking external financing for a project?

90. Define financial structure. Is it the same across various countries, if not why?

91. Should international businesses conform to local capital structure norms?

92. What are cash balances? Why are they important for a firm?

93. What are transaction costs? How can they be reduced?

94. Differentiate between a tax credit, a tax treaty, and a deferral principle. What is their importance in international business?

95. What are tax havens? What is their importance in international business?

96. How are dividend remittances used by firms to transfer funds from foreign subsidiaries to the parent company?

97. What are royalties and fees?

98. Define transfer price. Enumerate the benefits of manipulating transfer prices.

99. What are fronting loans? Why are they used by multinationals?

100.Why do firms prefer to hold cash balances at a centralized depository?

ch20 Key
1.
(p. 654)

Investment decisions, in international business, are decisions about how to finance a firm's activities. FALSE
AACSB: Analytic Skills Blooms: Knowledge Difficulty: Medium Hill - Chapter 20 #1 Learning Objective: 20-1

2.
(p. 654)

In international business, money management decisions are decisions about how to manage the firm's financial resources most efficiently. TRUE
AACSB: Analytic Skills Blooms: Knowledge Difficulty: Easy Hill - Chapter 20 #2 Learning Objective: 20-1

3.
(p. 655)

Capital budgeting quantifies the benefits, costs, and risks of an investment. TRUE
AACSB: Analytic Skills Blooms: Comprehension Difficulty: Medium Hill - Chapter 20 #3 Learning Objective: 20-1

4.
(p. 655)

A firm's cash flows will be negative at first. TRUE


AACSB: Analytic Skills Blooms: Knowledge Difficulty: Easy Hill - Chapter 20 #4 Learning Objective: 20-1

5.
(p. 655)

If the net present value of the discounted cash flows is slightly less than zero, the firm should go ahead with the project. FALSE
AACSB: Analytic Skills Blooms: Comprehension Difficulty: Medium Hill - Chapter 20 #5 Learning Objective: 20-1

6.
(p. 656)

The problem of blocked earnings is much more serious than it was previously. FALSE
AACSB: Analytic Skills Blooms: Knowledge Difficulty: Medium Hill - Chapter 20 #6 Learning Objective: 20-1

7.
(p. 656)

When using capital budgeting techniques to evaluate a potential foreign project, cash flows to the project and cash flows to the parent must be considered as one. FALSE
AACSB: Analytic Skills Blooms: Comprehension Difficulty: Medium Hill - Chapter 20 #7 Learning Objective: 20-1

8.
(p. 656)

Stockholders perceive blocked earnings as contributing to the value of the firm. FALSE
AACSB: Analytic Skills Blooms: Comprehension Difficulty: Medium Hill - Chapter 20 #8 Learning Objective: 20-1

9.
(p. 656657)

In recent decades, the risk of outright expropriations has increased. FALSE


AACSB: Analytic Skills Blooms: Knowledge Difficulty: Easy Hill - Chapter 20 #9 Learning Objective: 20-1

10.
(p. 657)

Political risk assessment is more art than science. TRUE


AACSB: Analytic Skills Blooms: Knowledge Difficulty: Medium Hill - Chapter 20 #10 Learning Objective: 20-1

11.
(p. 658)

In practice, the biggest problem arising from economic mismanagement has been rising interest rates. FALSE
AACSB: Analytic Skills Blooms: Knowledge Difficulty: Medium Hill - Chapter 20 #11 Learning Objective: 20-1

12.
(p. 658)

Empirical studies show that there is a long-run relationship between a country's relative inflation rates and changes in exchange rates. TRUE
AACSB: Analytic Skills Blooms: Knowledge Difficulty: Medium Hill - Chapter 20 #12 Learning Objective: 20-1

13.
(p. 658)

Adjusting discount rates to reflect a location's riskiness is a rare practice. FALSE


AACSB: Analytic Skills Blooms: Knowledge Difficulty: Medium Hill - Chapter 20 #13 Learning Objective: 20-1

14.
(p. 659)

The cost of capital is typically higher in the global capital market, by virtue of its size and liquidity, than in many domestic capital markets. FALSE
AACSB: Analytic Skills Blooms: Knowledge Difficulty: Medium Hill - Chapter 20 #14 Learning Objective: 20-2

15.
(p. 659)

The amount of local currency required to meet interest payments and retire principal on local debt obligations is not affected when a country's currency depreciates. TRUE
AACSB: Analytic Skills Blooms: Comprehension Difficulty: Medium Hill - Chapter 20 #15 Learning Objective: 20-2

16.
(p. 659)

Different tax regimes can determine the relative attractiveness of debt and equity in a country. TRUE
AACSB: Analytic Skills Blooms: Knowledge Difficulty: Medium Hill - Chapter 20 #16 Learning Objective: 20-2

17.
(p. 660)

Efficient money management involves minimizing cash balances and reducing transaction costs. TRUE
AACSB: Analytic Skills Blooms: Knowledge Difficulty: Easy Hill - Chapter 20 #17 Learning Objective: 20-3

18.
(p. 660)

Money market accounts typically offer a relatively high rate of interest. FALSE
AACSB: Analytic Skills Blooms: Knowledge Difficulty: Medium Hill - Chapter 20 #18 Learning Objective: 20-3

19.
(p. 660)

Transaction costs arise when cash moves from one location to another. FALSE
AACSB: Analytic Skills Blooms: Knowledge Difficulty: Medium Hill - Chapter 20 #19 Learning Objective: 20-3

20.
(p. 661)

Many nations follow the worldwide principle that they have the right to tax income earned outside their boundaries by entities based in their country. TRUE
AACSB: Analytic Skills Blooms: Knowledge Difficulty: Easy Hill - Chapter 20 #20 Learning Objective: 20-3

21.
(p. 661)

Double taxation is mitigated to some extent by tax credits, tax treaties, and the deferral principle. TRUE
AACSB: Analytic Skills Blooms: Knowledge Difficulty: Medium Hill - Chapter 20 #21 Learning Objective: 20-3

22.
(p. 661)

A deferral principle specifies that parent companies are not taxed on foreign source income until they actually receive a dividend. TRUE
AACSB: Analytic Skills Blooms: Knowledge Difficulty: Easy Hill - Chapter 20 #22 Learning Objective: 20-3

23.
(p. 662)

International businesses avoid or defer income taxes by establishing a wholly owned, nonoperating subsidiary in the tax haven. TRUE
AACSB: Analytic Skills Blooms: Knowledge Difficulty: Easy Hill - Chapter 20 #23 Learning Objective: 20-3

24.
(p. 662)

U.S. regulations tax U.S. shareholders on the firm's overseas income when it is earned, regardless of when the parent company in the United States receives it. TRUE
AACSB: Analytic Skills Blooms: Knowledge Difficulty: Medium Hill - Chapter 20 #24 Learning Objective: 20-3

25.
(p. 662)

The practice of unbundling refers solely to the use of royalty payments and fees to transfer liquid funds across borders. FALSE
AACSB: Analytic Skills Blooms: Knowledge Difficulty: Medium Hill - Chapter 20 #25 Learning Objective: 20-3

26.
(p. 662)

Fronting loans is the most common method by which firms transfer funds from foreign subsidiaries to the parent company. FALSE
AACSB: Analytic Skills Blooms: Knowledge Difficulty: Medium Hill - Chapter 20 #26 Learning Objective: 20-3

27.
(p. 663)

Fees are usually levied as a percentage of a subsidiary's gross revenues. FALSE


AACSB: Analytic Skills Blooms: Knowledge Difficulty: Medium Hill - Chapter 20 #27 Learning Objective: 20-3

28.
(p. 663)

Most governments are in favor of transfer pricing. FALSE


AACSB: Analytic Skills Blooms: Comprehension Difficulty: Medium Hill - Chapter 20 #28 Learning Objective: 20-3

29.
(p. 663)

Dividends have certain tax advantages over royalties and fees, particularly when the corporate tax rate is higher in the host country than in the parent's home country. FALSE
AACSB: Analytic Skills Blooms: Comprehension Difficulty: Medium Hill - Chapter 20 #29 Learning Objective: 20-3

30.
(p. 664)

Transfer pricing is consistent with a policy of treating each subsidiary in the firm as a profit center. FALSE
AACSB: Analytic Skills Blooms: Comprehension Difficulty: Medium Hill - Chapter 20 #30 Learning Objective: 20-3

31.
(p. 664)

The correct transfer price, according to the IRS guidelines, is an arm's-length price. TRUE
AACSB: Analytic Skills Blooms: Knowledge Difficulty: Medium Hill - Chapter 20 #31 Learning Objective: 20-3

32.
(p. 664665)

In a fronting loan, the parent company lends cash directly to the foreign subsidiary, and the subsidiary repays it later. FALSE
AACSB: Analytic Skills Blooms: Knowledge Difficulty: Medium Hill - Chapter 20 #32 Learning Objective: 20-3

33.
(p. 665)

Fronting loans can circumvent host country restrictions on the remittance of funds from a foreign subsidiary to the parent company. TRUE
AACSB: Analytic Skills Blooms: Knowledge Difficulty: Medium Hill - Chapter 20 #33 Learning Objective: 20-3

34.
(p. 665)

A fronting loan does not provide any tax advantage. FALSE


AACSB: Analytic Skills Blooms: Knowledge Difficulty: Easy Hill - Chapter 20 #34 Learning Objective: 20-3

35.
(p. 666)

Cash balances are typically deposited in liquid accounts. TRUE


AACSB: Analytic Skills Blooms: Knowledge Difficulty: Easy Hill - Chapter 20 #35 Learning Objective: 20-4

36.
(p. 666)

By pooling its cash reserves, a firm can reduce the total size of the cash pool it must hold in highly liquid accounts. TRUE
AACSB: Analytic Skills Blooms: Comprehension Difficulty: Medium Hill - Chapter 20 #36 Learning Objective: 20-4

37.
(p. 666)

Cash needs are assumed to be normally distributed in each country and independent of each other. TRUE
AACSB: Analytic Skills Blooms: Comprehension Difficulty: Medium Hill - Chapter 20 #37 Learning Objective: 20-4

38.
(p. 667)

Many firms hold at least their subsidiaries' precautionary cash reserves at a centralized depository, having each subsidiary hold its own day-to-day-needs cash balance. TRUE
AACSB: Analytic Skills Blooms: Comprehension Difficulty: Medium Hill - Chapter 20 #38 Learning Objective: 20-4

39.
(p. 667)

Multilateral netting compounds the transaction costs that arise when many transactions occur between a firm and its subsidiaries. FALSE
AACSB: Analytic Skills Blooms: Knowledge Difficulty: Medium Hill - Chapter 20 #39 Learning Objective: 20-4

40.
(p. 667)

Multilateral netting is an extension of bilateral netting. TRUE


AACSB: Analytic Skills Blooms: Knowledge Difficulty: Easy Hill - Chapter 20 #40 Learning Objective: 20-4

41.
(p. 654)

In international business, decisions about what activities to finance are best known as: A. B. C. D. investment decisions. financing decisions. money management decisions. economic decisions.

A decision to invest in activities in a given country must consider many economic, political, cultural, and strategic variables.
AACSB: Analytic Skills Blooms: Knowledge Difficulty: Medium Hill - Chapter 20 #41 Learning Objective: 20-1

42.
(p. 654)

Theses are decisions about how to manage the firm's financial resources most efficiently. A. B. C. D. Investment decisions Financing decisions Money management decisions Economic decisions

Investment decisions are decisions about what activities to finance. Financing decisions are decisions about how to finance those activities.
AACSB: Analytic Skills Blooms: Knowledge Difficulty: Easy Hill - Chapter 20 #42 Learning Objective: 20-1

43.
(p. 654)

In international business, financing decisions are: A. B. C. D. decisions about what activities to finance. decisions about how to finance a firms activities. decisions about how to manage the firm's financial resources most efficiently. decisions about the operational activities of a firm.

Decisions about what activities to finance are investment decisions while decisions about how to manage a firm's financial resources efficiently are money management decisions.
AACSB: Analytic Skills Blooms: Knowledge Difficulty: Easy Hill - Chapter 20 #43 Learning Objective: 20-1

44.
(p. 654)

Good financial management can help a firm in all of the following ways, except: A. B. C. D. reduce the costs of creating value. add value by improving customer service. reduce the firm's cost of capital. totally eliminate the firm's tax burden.

Good financial management can minimize the firm's tax burden.


AACSB: Analytic Skills Blooms: Comprehension Difficulty: Medium Hill - Chapter 20 #44 Learning Objective: 20-1

45.
(p. 655)

_____ can help financial managers in an international business to quantify the various benefits, costs, and risks that are likely to flow from an investment in a given location. A. B. C. D. Operational techniques Capital budgeting techniques Socio-economic techniques Production techniques

Capital budgeting enables top managers to compare different investment alternatives within and across countries so they can make informed choices about where the firm should invest its scarce financial resources.
AACSB: Analytic Skills Blooms: Knowledge Difficulty: Medium Hill - Chapter 20 #45 Learning Objective: 20-1

46.
(p. 655)

Capital budgeting: A. in practice is a very simple and perfect process. B. techniques are not useful for quantifying the benefits, costs, and risks of an investment. C. for a foreign project uses the same theoretical framework that domestic capital budgeting uses. D techniques, for evaluating potential foreign projects, do not require the firm to recognize the specific . risks arising from its foreign location. Capital budgeting quantifies the benefits, costs, and risks of an investment. Capital budgeting is in practice a very complex and imperfect process. Political and economic risks, including foreign exchange risk, can significantly change the value of a foreign investment.
AACSB: Analytic Skills Blooms: Comprehension Difficulty: Hard Hill - Chapter 20 #46 Learning Objective: 20-1

47.
(p. 655)

Which of the following statements is true regarding cash flows that a firm must estimate to decide if it should go ahead with a project? A. In most cases, the cash flows will be positive at first, because the firm is yet to invest heavily in production facilities. B. After some initial period the cash flows becomes negative as investment costs increase and revenues stabilize. C Once the cash flows have been estimated, they must be discounted to determine their net present . value using an appropriate discount rate. D. If the net present value of the discounted cash flows is less than zero, the firm should go ahead with the project. Cash flows will be negative at first because the firm will be investing heavily in production facilities. After some initial period, the cash flows will become positive as investment costs decline and revenues grow. If the net present value of the discounted cash flows is greater than zero, the firm should go ahead with the project.
AACSB: Analytic Skills Blooms: Comprehension Difficulty: Medium Hill - Chapter 20 #47 Learning Objective: 20-1

48.
(p. 656)

All of the following are factors complicating the capital budgeting process for an international business except: A. a distinction must be made between cash flows to the project and cash flows to the parent company. B cash flows to the project and to the parent company will be the same when a host-country government . blocks the repatriation of cash flows from a foreign investment. C. political and economic risks, including foreign exchange risk, can significantly change the value of a foreign investment. D. the connection between cash flows to the parent and the source of financing must be recognized. Cash flows to the project and cash flows to the parent will not be the same thing when a host-country government blocks the repatriation of cash flows from a foreign investment.
AACSB: Analytic Skills Blooms: Comprehension Difficulty: Hard Hill - Chapter 20 #48 Learning Objective: 20-1

49.
(p. 656)

Restrictions on a project, because of which a firm may not be able to remit all its cash flows to the parent company: A. do not affect the net present value of the project to the parent company. B. do not affect the net present value of the project itself. C. do not limit the cash flows of the parent company in any manner. D. establishes the fact that a foreign project need not be analyzed from the perspective of the parent company. Restrictions on a project do not affect the net present value of the project itself but they do affect the net present value of the project to the parent company because they limit the cash flows that can be remitted to it from the project. It is important for firms to analyze foreign projects from the perspective of the parent company.
AACSB: Analytic Skills Blooms: Comprehension Difficulty: Hard Hill - Chapter 20 #49 Learning Objective: 20-1

50.
(p. 656)

Which of the following statements is true about government restrictions that block earnings from a foreign project? A. The problem of blocked earnings is now much more serious than before. B. Greater acceptance of free market economics has increased the number of countries in which governments are likely to block earnings. C. Firms have few options for circumventing host-government attempts to block the free flow of funds from an affiliate. D. Stockholders do not perceive blocked earnings as contributing to the value of the firm. The problem of blocked earnings is not as serious as it once was. The worldwide move toward greater acceptance of free market economics has reduced the number of countries in which governments are likely to prohibit the affiliates of foreign multinationals from remitting cash flows to their parent companies. In addition, firms have a number of options for circumventing host-government attempts to block the free flow of funds from an affiliate.
AACSB: Analytic Skills Blooms: Comprehension Difficulty: Hard Hill - Chapter 20 #50 Learning Objective: 20-1

51.
(p. 656)

Identify the incorrect statement regarding political risk. A It can be defined it as the likelihood that political forces will cause drastic changes in a country's . business environment that hurt the profit and other goals of a business. B. It tends to be greater in countries where the underlying nature of the society makes the likelihood of social unrest high. C When political risk is high, there is a high probability that a change will occur in the country's . political environment that will endanger foreign firms there. D. In most cases, political change may result in the expropriation of foreign firms' assets. In extreme cases, political change may result in the expropriation of foreign firms' assets. In recent decades, the risk of outright expropriations has become almost zero.
AACSB: Analytic Skills Blooms: Knowledge Difficulty: Medium Hill - Chapter 20 #51 Learning Objective: 20-1

52.
(p. 657)

Political risk assessment: A. B. C. D. is without value. is more science than art. tries to predict a future that can only be guessed. usually makes correct future predictions.

The problem with all attempts to forecast political risk is that they try to predict a future that can only be guessed atand in many cases, the guesses are wrong. This is not to say that political risk assessment is without value, but it is more art than science.
AACSB: Analytic Skills Blooms: Comprehension Difficulty: Medium Hill - Chapter 20 #52 Learning Objective: 20-1

53.
(p. 658)

Historically, many governments have expanded their domestic money supply in misguided attempts to stimulate economic activity. The result has often been: A. B. C. D. price inflation. low interest rates. a strong local currency. private sector growth.

Price inflation is reflected in a drop in the value of a country's currency on the foreign exchange market.
AACSB: Analytic Skills Blooms: Knowledge Difficulty: Easy Hill - Chapter 20 #53 Learning Objective: 20-1

54.
(p. 658)

The relationship between a country's relative inflation rates and changes in exchange rates is: A. B. C. D. much closer than what theory would predict. not reliable in the short run. totally reliable in the long run. according to empirical studies, non existent in the long run.

Empirical studies demonstrate a long-run relationship between a country's relative inflation rates and changes in exchange rates. However, the relationship is not as close as theory would predict; it is not reliable in the short run, nor is it totally reliable in the long run.
AACSB: Analytic Skills Blooms: Comprehension Difficulty: Medium Hill - Chapter 20 #54 Learning Objective: 20-1

55.
(p. 658)

Adjusting discount rates to reflect a location's riskiness: A. B. C. D. is not widely practiced by firms. treats all risk as a single problem. penalizes distant cash flows too heavily. does not penalize early cash flows enough.

Adjusting discount rates to reflect a location's riskiness seems to be fairly widely practiced. Critics of this method argue that it penalizes early cash flows too heavily and does not penalize distant cash flows enough.
AACSB: Analytic Skills Blooms: Comprehension Difficulty: Hard Hill - Chapter 20 #55 Learning Objective: 20-1

56.
(p. 658)

One method of analyzing a foreign investment opportunity is to treat all risk as a single problem by adjusting the discount rate applicable. For countries with significant political and economic risks, the: A. B. C. D. discount rates are revised upward. discount rates are revised downward. early cash flows are not adjusted. distant cash flows are heavily penalized.

The additional risk that stems from location can be handled by treating all risk as a single problem by increasing the discount rate applicable to foreign projects in countries where political and economic risks are perceived as high.
AACSB: Analytic Skills Blooms: Comprehension Difficulty: Medium Hill - Chapter 20 #56 Learning Objective: 20-1

57.
(p. 659)

For firm's seeking external financing for a project, the cost of capital is typically lower in: A. B. C. D. global capital markets. domestic capital markets. small markets. relatively illiquid markets.

The cost of capital is typically lower in the global capital market, by virtue of its size and liquidity, than in many domestic capital markets, particularly those that are small and relatively illiquid.
AACSB: Analytic Skills Blooms: Knowledge Difficulty: Easy Hill - Chapter 20 #57 Learning Objective: 20-2

58.
(p. 659)

In capital budgeting decisions, the discount rate must be adjusted downward: A. B. C. D. in countries where liquidity is limited. when the cost of capital used to finance a project is high. in countries where governments offer foreign firms low-interest loans. in countries where the perceived political and economic risks are greater.

Some governments court foreign investment by offering foreign firms low-interest loans, lowering the cost of capital. Accordingly, the discount rate should be revised downward in such cases.
AACSB: Analytic Skills Blooms: Comprehension Difficulty: Medium Hill - Chapter 20 #58 Learning Objective: 20-2

59.
(p. 659)

If foreign debt obligation must be served, the amount of local currency required to do this will: A. B. C. D. increase as the currency depreciates, and this effectively raises the cost of capital. decrease as the currency depreciates, and this effectively decreases the cost of capital. increase as the currency appreciates, and this effectively raises the cost of capital. increase as the currency appreciates, and this effectively decreases the cost of capital.

The amount of local currency required to meet interest payments and retire principal on local debt obligations is not affected when a country's currency depreciates.
AACSB: Analytic Skills Blooms: Comprehension Difficulty: Medium Hill - Chapter 20 #59 Learning Objective: 20-2

60.
(p. 659)

Identify the correct statement pertaining to financial structures. A. The financial structures of firms are remarkably similar across countries. B. It can be described as the mix of debt and equity used to finance a business. C. If interest income were taxed at a high rate, a preference for equity financing over debt financing would be expected. D According to empirical research, country differences in financial structure are systematically related . to country differences in tax structure. Firms based in different countries have different financial structures. If interest income were taxed at a high rate, a preference for debt financing over equity financing would be expected. However, according to empirical research, country differences in financial structure do not seem related in any systematic way to country differences in tax structure.
AACSB: Analytic Skills Blooms: Comprehension Difficulty: Medium Hill - Chapter 20 #60 Learning Objective: 20-2

61.
(p. 660)

It is best recommended that an international business adopt a financial structure: A. B. C. D. that is consistent with host-country norms. that is insensitive to the local monetary policy. that minimizes the cost of capital. that allows it to easily evaluate its return on equity relative to local competitors in the same industry.

The best recommendation is that an international business should adopt a financial structure for each foreign affiliate that minimizes its cost of capital, irrespective of whether that structure is consistent with local practice.
AACSB: Analytic Skills Blooms: Knowledge Difficulty: Medium Hill - Chapter 20 #61 Learning Objective: 20-2

62.
(p. 660)

If a firm invests its cash balances in money market accounts: A. B. C. D. it will have unlimited liquidity and earn a high rate of interest. it will have unlimited liquidity but will earn a relatively low rate of interest. it will have limited liquidity but will earn a high rate of interest. it will have limited liquidity but will earn a low rate of interest.

If a firm invests its cash balances in money market accounts, it will have unlimited liquidity but earn a relatively low rate of interest. If it invests its cash in longer-term financial instruments, it will earn a higher rate of interest, but liquidity will be limited.
AACSB: Analytic Skills Blooms: Knowledge Difficulty: Medium Hill - Chapter 20 #62 Learning Objective: 20-3

63.
(p. 660)

The commission fee a firm pays to foreign exchange dealers for changing cash from one currency into another currency is known as: A. B. C. D. foreign exchange tax. transfer fee. transaction cost. conversion tax.

Transaction costs are the cost of exchange.


AACSB: Analytic Skills Blooms: Knowledge Difficulty: Easy Hill - Chapter 20 #63 Learning Objective: 20-3

64.
(p. 660)

These are the charges that most banks take for moving cash from one location to another. A. B. C. D. Currency taxes Location fee Exchange charges Transfer fee

Transfer fees are also a transaction cost.


AACSB: Analytic Skills Blooms: Knowledge Difficulty: Easy Hill - Chapter 20 #64 Learning Objective: 20-3

65.
(p. 661)

This occurs when both the host-country government and the parent company's home government tax the income of a foreign subsidiary. A. B. C. D. Double taxation Tax duplication Tax discrepancy Indirect taxation

Double taxation is mitigated to some extent by tax credits, tax treaties, and the deferral principle.
AACSB: Analytic Skills Blooms: Knowledge Difficulty: Easy Hill - Chapter 20 #65 Learning Objective: 20-3

66.
(p. 661)

A _____ allows an entity to reduce the taxes paid to the home government by the amount of taxes paid to the foreign government. A. B. C. D. tax treaty tax credit deferral principle tax benefit

A tax credit can be used to mitigate the impact of double taxation.


AACSB: Analytic Skills Blooms: Knowledge Difficulty: Easy Hill - Chapter 20 #66 Learning Objective: 20-3

67.
(p. 661)

A tax treaty: A. allows an entity to reduce the taxes paid to the home government by the amount of taxes paid to the foreign government. B. directs both the host-country government and the parent company's home government to tax the income of a foreign subsidiary. C is an agreement between two countries specifying what items of income will be taxed by the . authorities of the country where the income is earned. D. specifies that parent companies are not taxed on foreign source income until they actually receive a dividend. Tax treaties have important implications for how a firm should structure its internal payments system among foreign subsidiaries and the parent company.
AACSB: Analytic Skills Blooms: Knowledge Difficulty: Medium Hill - Chapter 20 #67 Learning Objective: 20-3

68.
(p. 662)

A tax haven: A. allows an entity to reduce the taxes paid to the home government and those paid to foreign governments. B. directs both the host-country government and the parent company's home government not to tax the income of a foreign subsidiary. C. specifies that parent companies are not taxed on foreign source income until they actually receive a dividend. D. is a country with an exceptionally low, or even no, income tax. International businesses avoid or defer income taxes by establishing a wholly owned, nonoperating subsidiary in a tax haven.
AACSB: Analytic Skills Blooms: Knowledge Difficulty: Easy Hill - Chapter 20 #68 Learning Objective: 20-3

69.
(p. 662)

By using a mix of techniques to transfer liquid funds from a foreign subsidiary to the parent company, _____ allow(s) an international business to recover funds from its foreign subsidiaries without piquing host-country sensitivities with large "dividend drains." A. B. C. D. unbundling tax treaties the deferral principle tax havens

International businesses use a number of techniques to transfer liquid funds across borders such as dividend remittances, royalty payments and fees, transfer prices, and fronting loans. Some firms rely on more than one of these techniques to transfer funds across bordersa practice known as unbundling.
AACSB: Analytic Skills Blooms: Knowledge Difficulty: Medium Hill - Chapter 20 #69 Learning Objective: 20-3

70.
(p. 662)

The payment of dividends is an attractive option: A. B. C. D. when the rate of tax levied on dividends by the host-country government is high. for subsidiaries based in "high-risk" countries. for newly established subsidiaries. when local equity participation is limited.

With regard to foreign exchange risk, firms sometimes require foreign subsidiaries based in "high-risk" countries to speed up the transfer of funds to the parent through accelerated dividend payments. This moves corporate funds out of a country whose currency is expected to depreciate significantly.
AACSB: Analytic Skills Blooms: Knowledge Difficulty: Medium Hill - Chapter 20 #70 Learning Objective: 20-3

71.
(p. 662)

Which of the following represents the remuneration paid to the owners of technology, patents, or trade names for the use of that technology or the right to manufacture and/or sell products under those patents or trade names? A. B. C. D. Trademarks Royalties Copyrights Transfer fees

It is common for a parent company to charge its foreign subsidiaries royalties for the technology, patents, or trade names it has transferred to them.
AACSB: Analytic Skills Blooms: Knowledge Difficulty: Medium Hill - Chapter 20 #71 Learning Objective: 20-3

72.
(p. 663)

Which of the following statements is true regarding royalties and fees? A. Royalties may be levied as fixed charges for the particular services provided. B.A fee may be levied as a fixed monetary amount per unit of the product the subsidiary sells or as a percentage of a subsidiary's gross revenues. C Royalties may be differentiated into "management royalties" for general expertise and advice . and "technical assistance royalties" for guidance in technical matters. D Royalties and fees are often tax-deductible locally, so arranging for payment in royalties and fees will . reduce a foreign subsidiary's tax liability. Royalties may be levied as a fixed monetary amount per unit of the product the subsidiary sells or as a percentage of a subsidiary's gross revenues. Fees are sometimes differentiated into "management fees" for general expertise and advice and "technical assistance fees" for guidance in technical matters. Fees are usually levied as fixed charges for the particular services provided.
AACSB: Analytic Skills Blooms: Comprehension Difficulty: Medium Hill - Chapter 20 #72 Learning Objective: 20-3

73.
(p. 663)

The price at which goods and services are transferred between entities within the firm is referred to as: A. B. C. D. transfer tax. service tax. service charges. transfer price.

Transfer prices can be used to position funds within an international business.


AACSB: Analytic Skills Blooms: Knowledge Difficulty: Easy Hill - Chapter 20 #73 Learning Objective: 20-3

74.
(p. 663)

All of the following are gains that can be derived by manipulating transfer prices, except: A. a firm can reduce its tax liabilities by shifting earnings from a high-tax country to a low-tax one. B a firm can move funds out of a country where a significant currency devaluation is expected, thereby . reducing its exposure to foreign exchange risk. C funds can be moved by a firm from a subsidiary to the parent company when financial transfers in the . form of dividends are blocked by host-country government policies. D if there are high transfer prices on goods or services being imported into the country, a firm can . reduce the import duties it must pay when an ad valorem tariff is in force. The firm can use transfer prices to reduce the import duties it must pay when an ad valorem tariff is in force. In this case, low transfer prices on goods or services being imported into the country are required. Since this lowers the value of the goods or services, it lowers the tariff.
AACSB: Analytic Skills Blooms: Comprehension Difficulty: Hard Hill - Chapter 20 #74 Learning Objective: 20-3

75.
(p. 664)

Which of the following statements is true regarding transfer pricing? A. Most governments favor the use of transfer pricing. B The correct transfer price, according to the IRS guidelines, is an arm's-length pricethe price that . would prevail between unrelated firms in a market setting. C. Transfer pricing is consistent with a policy of treating each subsidiary in the firm as a profit center. D. The opportunity for price manipulation is much greater with arm's-length pricing than it is for costbased transfer pricing. Few governments like transfer pricing. Transfer pricing is inconsistent with a policy of treating each subsidiary in the firm as a profit center. The opportunity for price manipulation is much greater with cost-based transfer pricing.
AACSB: Analytic Skills Blooms: Comprehension Difficulty: Hard Hill - Chapter 20 #75 Learning Objective: 20-3

76.
(p. 664)

This is a loan between a parent and its subsidiary channeled through a financial intermediary, usually a large international bank. A. B. C. D. International loan Fronting loan Transfer loan Unbundling loan

In a fronting loan, the parent company deposits funds in an international bank, and the bank then lends the same amount to the foreign subsidiary.
AACSB: Analytic Skills Blooms: Knowledge Difficulty: Easy Hill - Chapter 20 #76 Learning Objective: 20-3

77.
(p. 664665)

A fronting loan: A helps a multinational to make a direct intrafirm loan, where the parent company lends cash directly to . the foreign subsidiary, and the subsidiary repays it later. B. can circumvent host-country restrictions on the remittance of funds from a foreign subsidiary to the parent company. C. is suitable for lending funds to subsidiaries based in countries which are politically stable. D. offers insignificant tax advantages. A fronting loan is a loan between a parent and its subsidiary channeled through a financial intermediary, usually a large international bank. International businesses sometimes use fronting loans when they want to lend funds to a subsidiary based in a country with a fairly high probability of political turmoil that might lead to restrictions on capital flows. A fronting loan can also provide tax advantages.
AACSB: Analytic Skills Blooms: Comprehension Difficulty: Medium Hill - Chapter 20 #77 Learning Objective: 20-3

78.
(p. 666)

In general, firms prefer to hold cash balances at a centralized depository for all of the following reasons except: A. by pooling cash reserves centrally, the firm can deposit larger amounts. B.it enables the firm to invest a larger amount of cash reserves in short-term, highly liquid financial instruments that earn a lower interest rate. C if the centralized depository is located in a major financial center, it has access to information about . good short-term investment opportunities that the typical foreign subsidiary would lack. D. the firm can reduce the total size of the cash pool it must hold in highly liquid accounts. By pooling its cash reserves, a firm can reduce the total size of the cash pool it must hold in highly liquid accounts, which enables the firm to invest a larger amount of cash reserves in longer-term, less liquid financial instruments that earn a higher interest rate.
AACSB: Analytic Skills Blooms: Comprehension Difficulty: Hard Hill - Chapter 20 #78 Learning Objective: 20-4

79.
(p. 667)

A French subsidiary owes a Mexican subsidiary $6 million and the Mexican subsidiary simultaneously owes the French subsidiary $4 million. Through a mutual settlement a single payment of $2 million is made from the French subsidiary to the Mexican subsidiary, the remaining debt being canceled. This example best exemplifies: A. B. C. D. bilateral netting. a transfer loan. multilateral netting. a fronting loan.

Under bilateral netting, a bilateral settlement will be made with a single payment of $2 million from the French subsidiary to the Mexican subsidiary, the remaining debt being canceled.
AACSB: Analytic Skills Blooms: Application Difficulty: Medium Hill - Chapter 20 #79 Learning Objective: 20-4

80.
(p. 667)

Which of the following allows a multinational firm to reduce the transaction costs that arise when many transactions occur between its subsidiaries? A. B. C. D. Unbundling Deferral principle Fronting loan Multilateral netting

Netting reduces transaction costs by reducing the number of transactions.


AACSB: Analytic Skills Blooms: Knowledge Difficulty: Easy Hill - Chapter 20 #80 Learning Objective: 20-4

81.
(p. 654)

Identify the main sets of related decisions included within the scope of financial management in the international business. Three sets of related decisions, included within the scope of financial management are: Investment decisionsdecisions about what activities to finance. Financing decisionsdecisions about how to finance those activities. Money management decisionsdecisions about how to manage the firm's financial resources most efficiently.
AACSB: Analytic Skills Blooms: Knowledge Difficulty: Easy Hill - Chapter 20 #81 Learning Objective: 20-1

82.
(p. 654)

What is the role of investment, financing, and money management decisions in an international business? In an international business, investment, financing, and money management decisions are complicated by the fact that countries have different currencies, different tax regimes, different regulations concerning the flow of capital across their borders, different norms regarding the financing of business activities, different levels of economic and political risk, and so on. Financial managers must consider all these factors when deciding which activities to finance, how best to finance those activities, how best to manage the firm's financial resources, and how best to protect the firm from political and economic risks. Good financial management can be an important source of competitive advantage.
AACSB: Analytic Skills Blooms: Knowledge Difficulty: Medium Hill - Chapter 20 #82 Learning Objective: 20-1

83.
(p. 655)

What is capital budgeting? Capital budgeting quantifies the benefits, costs, and risks of an investment. This enables top managers to compare, in a reasonably objective fashion, different investment alternatives within and across countries so they can make informed choices about where the firm should invest its scarce financial resources. In capital budgeting a firm must first estimate the cash flows associated with the project over time. In most cases, the cash flows will be negative at first, because the firm will be investing heavily in production facilities. After some initial period, however, the cash flows will become positive as investment costs decline and revenues grow. Once the cash flows have been estimated, they must be discounted to determine their net present value using an appropriate discount rate. The most commonly used discount rate is either the firm's cost of capital or some other required rate of return. If the net present value of the discounted cash flows is greater than zero, the firm should go ahead with the project.
AACSB: Analytic Skills Blooms: Comprehension Difficulty: Medium Hill - Chapter 20 #83 Learning Objective: 20-1

84.
(p. 656)

What are the factors complicating the process of capital budgeting for an international business? Capital budgeting is in practice a very complex and imperfect process. Following are the factors complicating the process for an international business: 1. A distinction must be made between cash flows to the project and cash flows to the parent company. 2. Political and economic risks, including foreign exchange risk, can significantly change the value of a foreign investment. 3. The connection between cash flows to the parent and the source of financing must be recognized.
AACSB: Analytic Skills Blooms: Comprehension Difficulty: Medium Hill - Chapter 20 #84 Learning Objective: 20-1

85.
(p. 656)

Should a foreign project be analyzed from the perspective of the parent company? A theoretical argument exists for analyzing any foreign project from the perspective of the parent company because cash flows to the project are not necessarily the same thing as cash flows to the parent company. The project may not be able to remit all its cash flows to the parent for a number of reasons. Cash flows may be blocked from repatriation by the host-country government, they may be taxed at an unfavorable rate, or the host government may require that a percentage of cash flows generated from the project be reinvested within the host nation. While these restrictions don't affect the net present value of the project itself, they do affect the net present value of the project to the parent company because they limit the cash flows that can be remitted to it from the project.
AACSB: Analytic Skills Blooms: Comprehension Difficulty: Hard Hill - Chapter 20 #85 Learning Objective: 20-1

86.
(p. 656657)

What are political risks? Why must a company evaluating foreign investment opportunities consider the political risks that stem from the foreign location? Political risk can be defined as the likelihood that political forces will cause drastic changes in a country's business environment that hurt the profit and other goals of a business enterprise. When political risk is high, there is a high probability that a change will occur in the country's political environment that will endanger foreign firms there. In extreme cases, political change may result in the expropriation of foreign firms' assets. It may also result in economic collapse, which can render a firm's assets worthless. In less extreme cases, political changes may result in increased tax rates, the imposition of exchange controls that limit or block a subsidiary's ability to remit earnings to its parent company, the imposition of price controls, and government interference in existing contracts.
AACSB: Analytic Skills Blooms: Comprehension Difficulty: Medium Hill - Chapter 20 #86 Learning Objective: 20-1

87.
(p. 658)

What is economic risk? How does it affect international businesses? Economic risk can be defined as the likelihood that economic mismanagement will cause drastic changes in a country's business environment that hurt the profit and other goals of a business enterprise. The biggest problem arising from economic mismanagement has been inflation. Price inflation is reflected in a drop in the value of a country's currency on the foreign exchange market. This can be a serious problem for a foreign firm with assets in that country because the value of the cash flows it receives from those assets will fall as the country's currency depreciates on the foreign exchange market. The likelihood of this occurring decreases the attractiveness of foreign investment in that country.
AACSB: Analytic Skills Blooms: Comprehension Difficulty: Medium Hill - Chapter 20 #87 Learning Objective: 20-1

88.
(p. 658)

In analyzing a foreign investment opportunity, how can the additional risk that stems from its location be handled? The additional risk that stems from location can be handled in at least two ways. The first method is to treat all risk as a single problem by increasing the discount rate applicable to foreign projects in countries where political and economic risks are perceived as high. The higher the discount rate, the higher the projected net cash flows must be for an investment to have a positive net present value. The second method revises future cash flows downward. This method, rather than using a higher discount rate to evaluate risky projects, which penalizes early cash flows too heavily, revises future cash flows from the project downward to reflect the possibility of adverse political or economic changes sometime in the future.
AACSB: Analytic Skills Blooms: Comprehension Difficulty: Hard Hill - Chapter 20 #88 Learning Objective: 20-1

89.
(p. 659)

What are the factors a firm considers when seeking external financing for a project? If the firm is going to seek external financing for a project, it will want to borrow funds from the lowest cost source of capital available. Firms increasingly are turning to the global capital market to finance their investments. The cost of capital is typically lower in the global capital market, by virtue of its size and liquidity, than in many domestic capital markets, particularly those that are small and relatively illiquid. However, despite the trends towards deregulation of financial services, in some cases host-country government restrictions may rule out this option. In addition to the impact of host-government policies on the cost of capital and financing decisions, the firm may wish to consider local debt financing for investments in countries where the local currency is expected to depreciate on the foreign exchange market.
AACSB: Analytic Skills Blooms: Comprehension Difficulty: Hard Hill - Chapter 20 #89 Learning Objective: 20-2

90.
(p. 659)

Define financial structure. Is it the same across various countries, if not why? Financial structure can be defined as the mix of debt and equity used to finance a business. There is a difference in the financial structures of firms based in different countries. It is not clear why the financial structure of firms varies so much across countries. One possible explanation is that different tax regimes determine the relative attractiveness of debt and equity in a country. However, according to empirical research, country differences in financial structure do not seem related in any systematic way to country differences in tax structure. Another possibility is that these country differences may reflect cultural norms. This explanation may be valid, although the mechanism by which culture influences capital structure has not yet been explained.
AACSB: Analytic Skills Blooms: Comprehension Difficulty: Medium Hill - Chapter 20 #90 Learning Objective: 20-2

91.
(p. 660)

Should international businesses conform to local capital structure norms? One advantage claimed for conforming to host-country debt norms is that management can more easily evaluate its return on equity relative to local competitors in the same industry. Another point often made is that conforming to higher host-country debt norms can improve the image of foreign affiliates that have been operating with too little debt and thus appear insensitive to local monetary policy. Just how important this point is, however, has not been established. The best recommendation is that an international business should adopt a financial structure for each foreign affiliate that minimizes its cost of capital, irrespective of whether that structure is consistent with local practice.
AACSB: Analytic Skills Blooms: Comprehension Difficulty: Medium Hill - Chapter 20 #91 Learning Objective: 20-2

92.
(p. 660)

What are cash balances? Why are they important for a firm? For any given period, a firm must hold certain cash balances. This is necessary for serving any accounts and notes payable during that period and as a contingency against unexpected demands on cash. A firm typically invests its cash reserves in money market accounts so it can earn interest on them. However, it must be able to withdraw its money from those accounts freely. Such accounts typically offer a relatively low rate of interest. In contrast, the firm could earn a higher rate of interest if it could invest its cash resources in longer-term financial instruments. The problem with longer-term instruments, however, is that the firm cannot withdraw its money before the instruments mature without suffering a financial penalty. Thus, the firm faces a dilemma. If it invests its cash balances in money market accounts, it will have unlimited liquidity but earn a relatively low rate of interest. If it invests its cash in longer-term financial instruments, it will earn a higher rate of interest, but liquidity will be limited. In an ideal world, the firm would have minimal liquid cash balances.
AACSB: Analytic Skills Blooms: Comprehension Difficulty: Medium Hill - Chapter 20 #92 Learning Objective: 20-3

93.
(p. 660)

What are transaction costs? How can they be reduced? Transaction costs are the cost of exchange. Every time a firm changes cash from one currency into another currency it must bear a transaction costthe commission fee it pays to foreign exchange dealers for performing the transaction. Most banks also charge a transfer fee for moving cash from one location to another; this is another transaction cost. The commission and transfer fees arising from intrafirm transactions can be substantial. Multilateral netting can reduce the number of transactions between the firm's subsidiaries, thereby reducing the total transactions costs arising from foreign exchange dealings and transfer fees.
AACSB: Analytic Skills Blooms: Knowledge Difficulty: Medium Hill - Chapter 20 #93 Learning Objective: 20-3

94.
(p. 661)

Differentiate between a tax credit, a tax treaty, and a deferral principle. What is their importance in international business? A tax credit allows an entity to reduce the taxes paid to the home government by the amount of taxes paid to the foreign government. A tax treaty between two countries is an agreement specifying what items of income will be taxed by the authorities of the country where the income is earned. A deferral principle specifies that parent companies are not taxed on foreign source income until they actually receive a dividend. For the international business with activities in many countries, the various tax regimes and tax treaties have important implications for how the firm should structure its internal payments system among the foreign subsidiaries and the parent company. The firm can use transfer prices and fronting loans to minimize its global tax liability. In addition, the form in which income is remitted from a foreign subsidiary to the parent company can be structured to minimize the firm's global tax liability.
AACSB: Analytic Skills Blooms: Comprehension Difficulty: Medium Hill - Chapter 20 #94 Learning Objective: 20-3

95.
(p. 662)

What are tax havens? What is their importance in international business? A tax haven is a country with an exceptionally low, or even no, income tax. Some firms use tax havens such as the Bahamas and Bermuda to minimize their tax liability. International businesses avoid or defer income taxes by establishing a wholly owned, nonoperating subsidiary in the tax haven. The tax haven subsidiary owns the common stock of the operating foreign subsidiaries. This allows all transfers of funds from foreign operating subsidiaries to the parent company to be funneled through the tax haven subsidiary. The tax levied on foreign source income by a firm's home government, which might normally be paid when a foreign subsidiary declares a dividend, can be deferred under the deferral principle until the tax haven subsidiary pays the dividend to the parent. This dividend payment can be postponed indefinitely if foreign operations continue to grow and require new internal financing from the tax haven affiliate.
AACSB: Analytic Skills Blooms: Comprehension Difficulty: Medium Hill - Chapter 20 #95 Learning Objective: 20-3

96.
(p. 662)

How are dividend remittances used by firms to transfer funds from foreign subsidiaries to the parent company? Payment of dividends is probably the most common method by which firms transfer funds from foreign subsidiaries to the parent company. The dividend policy typically varies with each subsidiary depending on such factors as tax regulations, foreign exchange risk, the age of the subsidiary, and the extent of local equity participation. With regard to foreign exchange risk, firms sometimes require foreign subsidiaries based in "high-risk" countries to speed up the transfer of funds to the parent through accelerated dividend payments. This moves corporate funds out of a country whose currency is expected to depreciate significantly. The age of a foreign subsidiary influences dividend policy in that older subsidiaries tend to remit a higher proportion of their earnings in dividends to the parent, presumably because a subsidiary has fewer capital investment needs as it matures. Local equity participation is a factor because local co-owners' demands for dividends must be recognized.
AACSB: Analytic Skills Blooms: Comprehension Difficulty: Medium Hill - Chapter 20 #96 Learning Objective: 20-3

97.
(p. 662663)

What are royalties and fees? Royalties represent the remuneration paid to the owners of technology, patents, or trade names for the use of that technology or the right to manufacture and/or sell products under those patents or trade names. It is common for a parent company to charge its foreign subsidiaries royalties for the technology, patents, or trade names it has transferred to them. Royalties may be levied as a fixed monetary amount per unit of the product the subsidiary sells or as a percentage of a subsidiary's gross revenues. A fee is compensation for professional services or expertise the parent company or another subsidiary supplies to a foreign subsidiary. Fees are sometimes differentiated into "management fees" for general expertise and advice and "technical assistance fees" for guidance in technical matters. Fees are usually levied as fixed charges for the particular services provided.
AACSB: Analytic Skills Blooms: Knowledge Difficulty: Medium Hill - Chapter 20 #97 Learning Objective: 20-3

98.
(p. 663)

Define transfer price. Enumerate the benefits of manipulating transfer prices. The price at which goods and services are transferred between entities within the firm is referred to as the transfer price. At least four gains can be derived by manipulating transfer prices: 1. The firm can reduce its tax liabilities by using transfer prices to shift earnings from a high-tax country to a low-tax one. 2. The firm can use transfer prices to move funds out of a country where a significant currency devaluation is expected, thereby reducing its exposure to foreign exchange risk. 3. The firm can use transfer prices to move funds from a subsidiary to the parent company when financial transfers in the form of dividends are restricted or blocked by host-country government policies. 4. The firm can use transfer prices to reduce the import duties it must pay when an ad valorem tariff is in force. In this case, low transfer prices on goods or services being imported into the country are required. Since this lowers the value of the goods or services, it lowers the tariff.
AACSB: Analytic Skills Blooms: Comprehension Difficulty: Hard Hill - Chapter 20 #98 Learning Objective: 20-3

99.
(p. 664665)

What are fronting loans? Why are they used by multinationals? A fronting loan is a loan between a parent and its subsidiary channeled through a financial intermediary, usually a large international bank. Firms use fronting loans for two reasons. First, fronting loans can circumvent host-country restrictions on the remittance of funds from a foreign subsidiary to the parent company. A fronting loan can also provide tax advantages.
AACSB: Analytic Skills Blooms: Comprehension Difficulty: Medium Hill - Chapter 20 #99 Learning Objective: 20-3

100.
(p. 666)

Why do firms prefer to hold cash balances at a centralized depository? First, by pooling cash reserves centrally, the firm can deposit larger amounts. Cash balances are typically deposited in liquid accounts, such as overnight money market accounts. Because interest rates on such deposits normally increase with the size of the deposit, by pooling cash centrally, the firm should be able to earn a higher interest rate than it would if each subsidiary managed its own cash balances. Second, if the centralized depository is located in a major financial center, it should have access to information about good short-term investment opportunities that the typical foreign subsidiary would lack. Third, by pooling its cash reserves, the firm can reduce the total size of the cash pool it must hold in highly liquid accounts, which enables the firm to invest a larger amount of cash reserves in longer-term, less liquid financial instruments that earn a higher interest rate.
AACSB: Analytic Skills Blooms: Comprehension Difficulty: Hard Hill - Chapter 20 #100 Learning Objective: 20-4

ch20 Summary
Category AACSB: Analytic Skills Blooms: Application Blooms: Comprehension Blooms: Knowledge Difficulty: Easy Difficulty: Hard Difficulty: Medium Hill - Chapter 20 Learning Objective: 20-1 Learning Objective: 20-2 Learning Objective: 20-3 Learning Objective: 20-4 # of Questions 100 1 45 54 23 13 64 100 37 11 42 10