Multinational Financial Management:

An Overview
1
Chapter
B1 - 2
Chapter Objectives
To identify the main goal of the
multinational corporation (MNC) and
conflicts with that goal;
To describe the key theories that justify
international business; and
To explain the common methods used to
conduct international business.
B1 - 3
Goal of the MNC
The commonly accepted goal of an MNC is
to maximize shareholder wealth.
B1 - 4
Conflicts Against the MNC Goal
For corporations with shareholders who
differ from their managers, a conflict of
goals can exist - the agency problem.
Agency costs are normally larger for MNCs
than for purely domestic firms.
The sheer size of the MNC.
The scattering of distant subsidiaries.
The culture of foreign managers.
Subsidiary value versus overall MNC value.
B1 - 5
Impact of Management Control
The magnitude of agency costs can vary
with the management style of the MNC.
A centralized management style reduces
agency costs.
Increase agency Cost> However, a
decentralized style gives more control to
those managers who are closer to the
subsidiarys operations and environment.
B1 - 6
Centralized Multinational Financial Management
for an MNC with two subsidiaries, A and B
Financial
Managers
of Parent
Capital Expenditures
at A
Inventory and
Accounts
Receivable
Management at A
Cash
Management
at A
Financing at A
Capital Expenditures
at B
Inventory and
Accounts
Receivable
Management at B
Cash
Management
at B
Financing at B
B1 - 7
Decentralized Multinational Financial Management
for an MNC with two subsidiaries, A and B
Financial
Managers
of A
Capital Expenditures
at A
Inventory and
Accounts
Receivable
Management at A
Cash
Management
at A
Financing at A
Capital Expenditures
at B
Inventory and
Accounts
Receivable
Management at B
Cash
Management
at B
Financing at B
Financial
Managers
of B
B1 - 8
Impact of Management Control
Some MNCs attempt to strike a balance -
they allow subsidiary managers to make
the key decisions for their respective
operations, >> but the decisions are
monitored by the parents management.
B1 - 9
Impact of Management Control
Electronic networks make it easier for the
parent to monitor the actions and
performance of foreign subsidiaries.
For example, corporate intranet or internet
email facilitates communication. Financial
reports and other documents can be sent
electronically too.
B1 - 10
Impact of Corporate Control
Various forms of corporate control can
reduce agency costs.
Stock compensation for board members
and executives.
The threat of a hostile takeover.
Monitoring and intervention by large
shareholders.
B1 - 11
Constraints
Interfering with the MNCs Goal
As MNC managers attempt to maximize
their firms value, they may be confronted
with various constraints.
Environmental constraints.
Regulatory constraints.
Ethical constraints.>> Mini Discussion
B1 - 12
Why are firms motivated to expand
their business internationally?
Theories of International Business
Theory of Comparative Advantage
Specialization by countries can increase
production efficiency> Advance Technology
or Cheap labor
Imperfect Markets Theory
The markets for the various resources used
in production are imperfect.> immobility of
factors of production > Costly and Restricted
B1 - 13
Why are firms motivated to expand
their business internationally?
Theories of International Business
Product Cycle Theory
As a firm matures, it may recognize
additional opportunities outside its home
country.
B1 - 14
Firm exports
product to
accommodate
foreign demand.
Firm creates
product to
accommodate
local demand.
The International Product Life Cycle
Firm
establishes
foreign
subsidiary
to establish
presence in
foreign
country
and
possibly to
reduce
costs.
a. Firm
differentiates
product from
competitors
and/or expands
product line in
foreign country.
b. Firms
foreign
business
declines as its
competitive
advantages are
eliminated.
or
B1 - 15
International
Business Methods
International trade is a relatively
conservative approach involving
exporting and/or importing.
The internet facilitates international trade
by enabling firms to advertise and manage
orders through their websites.
There are several methods by which firms
can conduct international business.
B1 - 16
International
Business Methods
Licensing allows a firm to provide its
technology in exchange for fees or some
other benefits.> Quality control is difficult
Franchising obligates a firm to provide a
specialized sales or service strategy,
support assistance, and possibly an initial
investment in the franchise in exchange
for periodic fees.> KFC, McDonalds, Pizza
Hut
B1 - 17
International
Business Methods
Firms may also penetrate foreign markets
by engaging in a joint venture (joint
ownership and operation) with firms that
reside in those markets.> Xerox Corp
Acquisitions of existing operations in
foreign countries allow firms to quickly
gain control over foreign operations as
well as a share of the foreign market.
B1 - 18
International
Business Methods
Summary
Firms can also penetrate foreign markets
by establishing new foreign subsidiaries.
In general, any method of conducting
business that requires a direct investment
in foreign operations is referred to as a
direct foreign investment (DFI).
The optimal international business
method may depend on the characteristics
of the MNC.
B1 - 19
Degree of International Business by MNCs
26%
62%
58%
33%
47%
50%
66%
12%
46%
40%
0%
10%
20%
30%
40%
50%
60%
70%
Campbell's
Soup
Dow
Chemical
IBM Motorola Nike
Foreign Sales as a % of Total Sales
Foreign Assets as a % of Total Assets
B1 - 20
Managing for Value
Value of an MNC is important to stakeholders
Like domestic projects, foreign projects
involve an investment decision and a
financing decision.
When managers make multinational finance
decisions that maximize the overall present
value of future cash flows, they maximize the
firms value, and hence shareholder wealth.
B1 - 21
( )
( )

+
n
t
t
t
k
1 =
$,
1
CF E
= Value
E (CF
$,t
) = expected cash flows to be received at
the end of period t
n = the number of periods into the future
in which cash flows are received
k = the required rate of return by
investors
Valuation Model for an MNC
Domestic Model
B1 - 22
( ) ( ) | |
( )

=
n
t
t
m
j
t j t j
k
1 =
1
, ,
1
ER E CF E
= Value
E (CF
j,t
) = expected cash flows denominated in currency j
to be received by the U.S. parent at the end of
period t
E (ER
j,t
) = expected exchange rate at which currency j can
be converted to dollars at the end of period t
k = the weighted average cost of capital of the U.S.
parent company
Valuation Model for an MNC
Valuing International Cash Flows
B1 - 23
Valuation Model for an MNC
An MNCs financial decisions include how
much business to conduct in each country
and how much financing to obtain in each
currency.
Its financial decisions determine its
exposure to the international environment.
B1 - 24
Valuation Model for an MNC
Impact of New International Opportunities
on an MNCs Value
Exchange Rate Risk
( ) ( ) | |
( )

=
n
t
t
m
j
t j t j
k
1 =
1
, ,
1
ER E CF E
= Value
Political Risk
Exposure to
Foreign Economies
B1 - 25
Uncertainty Surrounding an MNCs
Cash Flows
International Economic Condition
Economic conditions affect demand> Income
International Political risk (country risk)
Political actions affect cash flows> Tax, barrier,
boycott by consumers
Exchange rate risk
Exchange rate fluctuations affect cash flows
and foreign demand> weak foreign currency
International business usually increases an
MNCs exposure to: