9/7/2021

Why international financial management is necessary?

International Corporate Finance

11th Edition
A highly globalized and integrated world
by Jeff Madura economy

Increase consumption

Boost up production

Expand investment

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Why international financial management is

necessary?
1Multinational Financial Management: An overview
Chapter Objectives
Foreign
Exchange
Risk

2. Why firms pursue

1. Managing MNCs
international business

Expanded
Opportunity
3. How firms engage
4. How to value an
Market Political in international
MNCs?
Imperfection Risk business

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1.1. Managing the MNC 1.1. Managing MNCs

1. Managers are expected to make decisions that

will maximize the stock price and serve the
shareholders’ interests.
2. Focus of this text: MNCs whose parents fully
own foreign subsidiaries (U.S. parent is sole
owner of subsidiary.)
3. Finance decisions are influenced by other
business discipline functions:
n Management
n Marketing
Chart: Relationship between principal and agent.
n Accounting and information systems
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TIME TO DISCUSS 1.1b Agency Problems

1. Discuss some problems that may occur between

principal and agent based on the following example. The conflict of goals between managers and
2. Suggest solutions to this problem. shareholders

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Agency Costs Control of Agency Problems

1. Definition: Cost of ensuring that managers 1. Parent control of agency problems

maximize shareholder wealth Parent should clearly communicate the goals for each
2. Costs are normally higher for MNCs than for purely subsidiary to ensure managers focus on maximizing the
domestic firms for several reasons: value of the subsidiary.
§ Monitoring managers of distant subsidiaries in foreign 2. Corporate control of agency problems
countries is more difficult. Entire management of the MNC must be focused on
§ Foreign subsidiary managers raised in different cultures maximizing shareholder wealth.
may not follow uniform goals.
3. Sarbanes-Oxley Act (SOX)
§ Sheer size of larger MNCs can create large agency
problems. Ensures a more transparent process for managers to report
on the productivity and financial condition of their firm.
§ Some non-U.S. managers tend to downplay the short-term
effects of decisions.
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1.1c. Management Structure of MNC Exhibit 1.1a Management Styles of MNCs

1. Centralized (See Exhibit 1.1a)

Allows managers of the parent to control
foreign subsidiaries and therefore reduce the
power of subsidiary managers
2. Decentralized (See Exhibit 1.1b)
Gives more control to subsidiary managers who
are closer to the subsidiary’s operation and
environment

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Exhibit 1.1b Management Styles of MNCs 1.2. Why Firms Pursue International Business

1. Theory of Comparative Advantage: specialization

increases production efficiency.
2. Imperfect Markets Theory: factors of production are
somewhat immobile providing incentive to seek out
foreign opportunities.
3. Product Cycle Theory: as a firm matures, it
recognizes opportunities outside its domestic
market.

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1.3. How Firms Engage in International

1.2. Why Firms Pursue International Business
Business

1. International trade (export & import).

2. Licensing.
3. Franchising.
4. Joint Ventures.
5. Acquisitions of existing operations
6. Establishing new foreign subsidiaries

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International Trade Licensing

n Relatively conservative approach that can be used n Ob lig ates a firm to p ro vide its tech nology
by firms to (copyrights, patents, trademarks, or trade names)
in exchange for fees or some other specified
n penetrate markets (by exporting)
benefits.
n obtain supplies at a low cost (by importing).
n Allows firms to use their technology in foreign
n Minimal risk – no capital at risk markets without a major investment and without
transportation costs that result from exporting
n The internet facilitates international trade by
allowing firms to advertise their products and n Major disadvantage: difficult to ensure quality
accept orders on their websites. control in foreign production process

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Franchising Joint Ventures

n Obligates firm to provide a specialized sales or n A venture that is jointly owned and operated by two or
service strategy, support assistance, and possibly more firms. A firm may enter the foreign market by
engaging in a joint venture with firms that reside in those
an initial investment in the franchise in exchange
markets.
for periodic fees.
n Allows two firms to apply their respective cooperative
n Allows penetration into foreign markets without a advantages in a given project.
major investment in foreign countries.

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Acquisitions of Existing Operations Establishing New Foreign Subsidiaries

n Acquisitions of firms in foreign countries allows n Firms can penetrate markets by establishing new
firms to have full control over their foreign operations in foreign countries.
businesses and to quickly obtain a large portion of
n Requires a large investment
foreign market share.
n Acquiring new as opposed to buying existing
n Subject to the risk of large losses because of larger
allows operations to be tailored exactly to the
investment.
firms needs.
n Liquidation may be difficult if the foreign
n May require smaller investment than buying
subsidiary performs poorly.
existing firm.

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Summary of Methods Exhibit 1.3 Cash Flow Diagrams for MNCs

n Any method of increasing international business

that requires a direct investment in foreign
operations is referred to as direct foreign
investment (DFI)
n International trade and licensing usually not
included
n Foreign acquisition and establishment of new
foreign subsidiaries represent the largest portion of
DFI.

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Exhibit 1.3 Cash Flow Diagrams for MNCs 1.4. Valuation Model for an MNC:
Domestic Model

n The first diagram reflects an MNC that engages in

international trade. International cash flows result from
 E CF$,t 
n
paying for imports or receiving cash flow from exports. V   t 
n The second diagram reflects an MNC that engages in some t 1  1  k  
international arrangements. Outflows include expenses
such as expenses incurred from transferring technology or Where
funding partial investment in a franchise or joint venture. § V represents present value of expected cash flows
Inflows are receipts from fees. § E(CF$,t) represents expected cash flows to be received at the
end of period t,
n The third diagram reflects an MNC that engages in direct § n represents the number of periods into the future in which
foreign investment. Cash flows exist between the parent cash flows are received, and
company and the foreign subsidiary. § k represents the required rate of return by investors.

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Valuation Model for an MNC: Valuation Model for an MNC

Multinational Model An MNC that uses two or more currencies

E CF$,t    E CFj ,t  E S j ,t    E CF$,t    E CFj ,t  E S j ,t   

m m

j 1 j 1
Where § Derive an expected dollar cash flow value for each currency
§ CFj,t represents the amount of cash flow denominated in a § Combine the cash flows among currencies within a given
particular foreign currency j at the end of period t, period

§ Sj,t represents the exchange rate at which the foreign currency

(measured in dollars per unit of the foreign currency) can be
converted to dollars at the end of period t.

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Uncertainty Surrounding MNC Cash

Example of Valuation Model for an MNC
Flows
An MNC that uses two or more
currencies

q Example 1: ABC company has expected cash

flows of $100,000 from local business and 1
million British Pounds from business in UK at
the end of period t. Assuming that the value of
GBP is expected to be $1.3 when converted into
USD. Calculate the expected dollar cash flows.
q Example 2: ABC company has expected cash
flows of $100,000 from local business and 1
million JPY from business in JP at the end of
period t. Assuming that the value of USD is
expected to be 106.91 JPY. Calculate the
expected dollar cash flows.
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Uncertainty Surrounding MNC Cash

Implication
Flows

1. Exposure to international economic conditions – If

economic conditions in a foreign country weaken, purchase Analyze the impact of Corona virus on MNC’s value
of products decline and MNC sales in that country may be based on valuation model for an MNC which is
lower than expected. operating in Vietnamese market.
2. Exposure to international political risk – A foreign
government may increase taxes or impose barriers on the
MNC’s subsidiary.
3. Exposure to exchange rate risk – If foreign currencies
related to the MNC subsidiary weaken against the U.S.
dollar, the MNC will receive a lower amount of dollar cash
flows than was expected.

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Exhibit 1.4 How an MNC’s Valuation is Exposed

Example of Austin Co.,
to Uncertainty

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Example of Austin Co., PRACTICE (Exercise 34 page 27)

n Assume that Bangor Co. (a U.S firm) knows that it will have cash
inflows of $900,000 from domestic operations, cash inflows of 200,000
Swiss francs due to exports to Swiss operations, and cash outflows of
500,000 Swiss francs at the end of the year. While the future value of
the Swiss franc is uncertain because it fluctuates, your best guess is that
the Swiss franc’s value will be $1.10 at the end this year. What are the
expected dollar cash flows of Bangor Co?
n Assume that Concord Co. (a U.S firm) is in the same industry as Bangor
Co. There is no political risk that could have any impact on the cash
flows of either firm. Concord co. knows that it will have cash inflows of
$900,000 from domestic operations, cash inflows of 700,000 Swiss
francs due to exports to Swiss operations, and cash outflows of 800,000
Swiss franc at the end of the year. Is the valuation of the total cash flows
of Concord Co, more uncertain or less uncertain than the total cash
flows of Bangor Co.? Explain briefly.

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Exhibit 1.5 Organization of Chapters

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