Financial Management of MNC

Financial Management in a MNC varies from the domestic firms. Financial strategies in international business begins from the very investment decision involving rigorous capital budgeting exercise to the selection of sources of funds and the management of day to day working capital. It is more complex because it involves multiple currencies, locations and economies.

Multinational Capital Budgeting

Capital Budgeting means investment appraisal It involves estimations for current and future cashflows and analyzing them with techniques such as payback period, NPV and IRR.

Issues in Multinational Capital Budgeting

1. Parent subsidiary perspective:
The debate is whether Capital budgeting should be from parent cos point of view or the subsidiaries perspective. It should be from the parent companys perspective because if the returns are not sufficient for the parent company, it will not decide to invest at all.

Issues in Multinational Capital Budgeting

2. Cash

flow Estimation

Initial Investment = Inv by parent co + Investment by subsidiary + Working capital inv - subsidies by host country govt. Annual Operating cash flows = sales by subsidiary in host country and exports + Imports from parent company Loss of exports by parent company Less : Operating exp Depreciation Taxes = PAT + Dep = Cashflows

Issues in Multinational Capital Budgeting

3.Cost of capital and Discount rate
Cost of capital for the parent company should be considered. Additional adjustment for exchange risk and political risk should be made which will increase the discount rate.

Issues in Multinational Capital Budgeting

4. Method of capital budgeting
APV ( adjusted net present value technique should be used NPV is computed in a 2 step approach 1) Evaluate the project considering the equity initial investment by parent and subsidiary company for the annual operating cash flows 2) Evaluate the initial investment done by borrowed funds. Cash flow = tax saving due to interest interest payment. 3) NPV = NPV1 + NPV 2

Issues in Multinational Capital Budgeting

5. Risk Analysis in capital Budgeting
The concept of risk analysis should be incorporated using sensitivity analysis ,Risk adjusted rate of discount and decision tree approach

International Cash Management

Cash is held by MNC for transaction motive, precautionary motive and speculative motive Cash management becomes necessary because there is Intra- firm flow of funds : 1. Subsidiary to subsidiary transfers 2. Parent to subsidiary transfers 3. Subsidiary to parent co. transfers Cash transfers have restrictions and taxes. To avoid the taxation, companies use following methods of transfers

Methods of cash transfers to avoid restrictions and taxes

Transfer Pricing : Higher payments made for
intra-company transfers of goods and services

Parallel loans :
US
Parent co A Loan to Subsidiary of B

INDIA
Parent co B Loan to subsidiary of A

Methods of cash transfers to avoid restrictions and taxes

Changes in Royalty / fees rates: Charge higher fees from surplus cash subsidiaries and lower fro deficit cash subsidiaries Use of blocked funds : Dividend to parent company is expensive because of dividend repatriation tax of 50%. Hence these blocked funds can be used to finance new subsidiaries.

Steps in Cash Management

Assessment of cash needs Optimization of cash by managing inflows and outflows Selecting sources of finance for funding cash defecits Investing surplus cash

1.Assessment of cash needs

Cash budgets are prepared for the subsidiaries and consolidated for the parent company Subsidiaries with surplus funds or deficit funds are identified to take further action

2.Optimization of cash by managing inflows and outflows

Encourage faster inflows and slow down the payments to minimize the need for extra cash. Bilateral and multilateral netting of payments is done to reduce transaction and conversions costs.

3. Selecting sources of finance for funding cash deficits

As far as possible intra-firm financing should be done. Methods to transfer funds from cash rich subsidiaries or parent companies may be used to avoid costs and taxes. External sources with minimum cost of capital should be considered.

4. Investing surplus cash

If surplus cash is available, there can be centralized or decentralized investment strategy. Centralized strategy is preferred to get economies of scale and diversificatin of risk.