FINANCIAL MANAGEMENT FOR MNC'S

Cost of capital
In economics and accounting, the cost of capital is the cost of a company's funds
(both debt and equity), or, from an investor's point of view "the required rate of return on a
portfolio company's existing securities". It is used to evaluate new projects of a company. It is
the minimum return that investors expect for providing capital to the company, thus setting a
benchmark that a new project has to meet.

Project valuation
Valuation analysis is used to evaluate the potential merits of an investment or to objectively
assess the value of a business or asset.

The Capital Structure for a Multinational Corporation

Multinational corporations leverage their financial position and access to global markets to raise
capital in a cost-effective and efficient manner. This gives these companies an advantage over small
domestic operators that do not have the same level of credit or cash, but there are risks associated
with international finance. The capital structure multinationals use directly impacts profitability,
growth and sustainability.

Invested Capital

A multinational’s capital structure comprises the sources of money used to finance operations,
expand production or purchase assets. Companies acquire capital through the sale of securities
in financial markets such as the New York Stock Exchange or the London Stock Exchange. Debt
and equity are the two forms of capital that multinationals have to choose from, and each form
has its advantages and disadvantages. The cost of raising capital is an important component of
financing decisions.
Debt Financing

Acquiring debt capital is a process that is contingent on the availability of funds in the global
credit markets, interest rates and a corporation’s existing debt obligations. If credit markets are
experiencing a contraction, it may be difficult for the corporation to sell corporate bonds at
favorable rates. In particular, it may be challenging to get high advance rates for asset-backed
securities. If a firm becomes over-leveraged, it may be unable to pay its debt obligations leading
to insolvency. However, debt costs less to acquire than other forms of financing.
Equity Financing
Preferred stock, common stock and components of retained earnings are considered equity
capital. It is important for a multinational to carefully analyze its equity cash flows and mitigate
the risk associated with currency fluctuations. Otherwise, it may lose equity due to changes in
exchange rates. Also, the issuance of new shares may cause stock prices to fall because
investors no longer feel company shares are worth their pre-issuance price. Offering stock in
global financial markets costs multinationals more than acquiring debt, but it may be the right
financing option if a corporation is already highly leveraged.
Tax Considerations
Multinationals have the option to shift income to jurisdictions where the tax treatment is the
most advantageous. As a result, debt and equity financing decisions are different relevant to
solely domestic companies. If income is reported in the United States, it may be beneficial to
obtain debt financing, because the interest is tax-deductible. When making capital structure
decisions, multinationals must evaluate their tax planning strategies to minimize their tax
liabilities.

Financing International Trade

Payment Methods for International Trade

• In any international trade transaction, credit is provided by either

– the supplier (exporter),

– the buyer (importer),

– one or more financial institutions, or

– any combination of the above.

• The form of credit whereby the supplier funds the entire trade cycle is known as supplier credit.
Method  : Prepayments

• The goods will not be shipped until the buyer has paid the seller.

• Time of payment : Before shipment

• Goods available to buyers : After payment

• Risk to exporter : None

• Risk to importer : Relies completely on exporter to ship goods as ordered

Method  : Letters of credit (L/C)

• These are issued by a bank on behalf of the importer promising to pay the exporter upon
presentation of the shipping documents.

• Time of payment : When shipment is made

• Goods available to buyers : After payment

• Risk to exporter : Very little or none

• Risk to importer : Relies on exporter to ship goods as described in documents

Method  : Drafts (Bills of Exchange)

• These are unconditional promises drawn by the exporter instructing the buyer to pay the face
amount of the drafts.

• Banks on both ends usually act as intermediaries in the processing of shipping documents and
the collection of payment. In banking terminology, the transactions are known as documentary
collections.

Method  : Consignments

• The exporter retains actual title to the goods that are shipped to the importer.

• Time of payment : At time of sale to third party

• Goods available to buyers : Before payment

• Risk to exporter : Allows importer to sell inventory before paying exporter

• Risk to importer : None

Method  : Open Accounts

• The exporter ships the merchandise and expects the buyer to remit payment according to the
agreed-upon terms.

• Time of payment : As agreed upon

• Goods available to buyers : Before payment

• Risk to exporter : Relies completely on buyer to pay account as agreed upon

• Risk to importer : None

Trade Finance Methods

 Accounts Receivable Financing

– An exporter that needs funds immediately may obtain a bank loan that is secured by an
assignment of the account receivable.

 Factoring (Cross-Border Factoring)

– The accounts receivable are sold to a third party (the factor), that then assumes all the
responsibilities and exposure associated with collecting from the buyer.

 Letters of Credit (L/C)

– These are issued by a bank on behalf of the importer promising to pay the exporter
upon presentation of the shipping documents.

– The importer pays the issuing bank the amount of the L/C plus associated fees.

– Commercial or import/export L/Cs are usually irrevocable.

 Documentary Credit Procedure
 Sale Contract
Buyer Seller
(Importer) (Exporter)
 Deliver Goods
   
Request Documents Present Deliver
for Credit & Claim for Documents Letter of
Payment Credit
 Present
Documents
Importer’s Bank Exporter’s Bank
(Issuing Bank)  Payment (Advising Bank)
 Send Credit

 Banker’s Acceptance (BA)

– This is a time draft that is drawn on and accepted by a bank (the importer’s bank). The
accepting bank is obliged to pay the holder of the draft at maturity.

– If the exporter does not want to wait for payment, it can request that the BA be sold in
the money market. Trade financing is provided by the holder of the BA.

 Working Capital Financing

– Banks may provide short-term loans that finance the working capital cycle, from the
purchase of inventory until the eventual conversion to cash.

 Medium-Term Capital Goods Financing (Forfaiting)

– The importer issues a promissory note to the exporter to pay for its imported capital
goods over a period that generally ranges from three to seven years.

– The exporter then sells the note, without recourse, to a bank (the forfaiting bank).

 Countertrade

– These are foreign trade transactions in which the sale of goods to one country is linked
to the purchase or exchange of goods from that same country.
 – Common countertrade types include barter, compensation (product buy-back), and
counterpurchase.

– The primary participants are governments and multinationals.

• Payment Methods for International Trade

– Prepayments

– Letters of Credit

– Sight Drafts and Time Drafts

– Consignments

– Open Accounts

• Trade Finance Methods

– Accounts Receivable Financing

– Factoring

– Letters of Credit

– Banker’s Acceptances

– Working Capital Financing

– Medium-Term Capital Goods Financing (Forfeiting)

– Countertrade