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Cost-Plus Method. Sets price by adding a appropriate profit markup to the seller's full cost ... Correspondent Banks with local banks across the world ... – PowerPoint PPT presentation

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Title: Contents of the course


1
International Finance
Part 2 International Corporate Finance
- Lecture n 10 Repositioning funds and working
capital management
2
Repositioning Funds
  • As an MNE aims at maximizing the shareholder
    value, one of its tasks is to reposition the
    profits as legally and as practically as
    possible, in low tax environments.
  • Repositioning profits is also useful to redeploy
    cash-flows or fund in more value-creating
    activities, or to minimize exposure to a currency
    collapse, or political crisis.
  • To this end, it can use a variety of techniques
  • Unbundling fund transfers
  • Dividend remittances
  • Payment of fees
  • Home overhead charges
  • Example Trident has operations in Brazil, China
    and Europe, each with their own constraints and
    opportunities for Trident to reposition funds

3
Repositioning Funds
4
Repositioning Funds
  • The strategy for each subsidiary will be
  • Trident Europe reposition profits from Germany
    to the US while maintaining the value of the
    European markets maturity
  • Trident Brazil reposition or in some way manage
    the capital at risk subject to foreign exchange
    risk while still providing adequate capital for
    growth
  • Trident China reposition the quantity of funds
    in and out of China to protect against transfer
    risk while balancing the needs of the joint
    venture partner

5
Repositioning Funds
  • Constraints on Positioning funds
  • Political constraints governments can block the
    movement of funds (transfer risk).
  • Tax constraints tax liabilities may prohibit
    fund transfer tax structures may be complex and
    possibly contradictory.
  • Transaction costs foreign exchange conversion
    and fees for money transfers. Become significant
    for large or frequent transfers. MNE avoid then
    unnecessary back-and-forth transfers.
  • Liquidity needs each subsidiary needs to
    maintain adequate working capital.

6
Conduits for Moving Funds
Payment to Parent Company
7
Transfer Pricing
  • Transfer pricing pricing of goods and services
    transferred to a foreign subsidiary from an
    affiliated company.
  • A parent wishing to reposition funds out of or
    into a particular country can charge higher or
    lower prices on goods sold among subsidiaries
  • This will affect the income statement of the
    subsidiary and effectively raise or lower taxes,
    with an opposite effect on the selling
    subsidiary.
  • Efficient conduit to avoid high taxation
    environments, but subject to abuses and,
    therefore, controls by the fiscal authorities.
    (see examples)

8
Transfer Pricing
  • Methods of determining transfer prices
  • Comparable Uncontrolled Price Method
  • Regarded as the best evidence of arms length
    pricing
  • A market determined price
  • Resale Price Method
  • Subtracts appropriate markup for the distribution
    subsidiary from the final selling price to an
    independent purchaser
  • Cost-Plus Method
  • Sets price by adding a appropriate profit markup
    to the sellers full cost
  • Often used where semi-finished products are sold
    between subsidiaries
  • Other Pricing Methods
  • Some tax authorities allow low pricing for
    establishment of new market so long as the cut
    price is passed on to final customer

9
License, Royalty Fees Shared Services
  • License fees remuneration paid to the owners of
    the patents, technologies, trade names, etc.
  • Usually based on a percentage of the value of the
    product or the volume of production
  • Royalty fees similar compensation paid for the
    use of intellectual property
  • Such fees are typically paid for identifiable
    services received by the subsidiary
  • Shared services also referred to as distributed
    charges or overhead, are charges to compensate
    the parent for costs incurred in the general
    management of international operations and other
    corporate services provided to the subsidiary.

10
Dividend Remittances
  • The classic way in which funds are transferred
    from subsidiary to parent
  • Dividend payout policies have change over the
    years and now incorporate several variables in
    determining the payout strategy. These are
  • Tax implications dividends are very
    tax-inefficient
  • Political risk incite firms to remit all funds
    locally generated that are not necessary to
    locally.
  • Foreign exchange risk if an FX loss is
    anticipated, the MNE will speed the transfer of
    funds.
  • Distributions and cash flows growth is not
    always accompanied with liquidity, especially is
    working capital funding are high.
  • Joint venture factors firms may be reluctant to
    vary the level of dividends paid, and tying its
    obligations toward the partner.

11
Leads and Lags
  • Firms can reduce both operating and transaction
    exposure by accelerating or decelerating the
    timing of payments that must be made or received
    in foreign currencies
  • To lead is to pay early
  • A firm holding a soft currency or debts
    denominated in hard currency will lead by using
    the soft currency to pay off the debts before the
    soft currency loses value.
  • To lag is to pay late
  • A firm holding a hard currency and debts
    denominated in soft currency will lag by using
    the hard currency to pay off the debts in hopes
    of having to use less of the hard currency
  • Leading and lagging is more feasible within a
    related firm

12
Reinvoicing Centers
  • A reinvoicing center is a separate corporate
    subsidiary that serves as an intermediary between
    the parent and all foreign subsidiaries. Title of
    ownership and invoices pass through the center
    but the physical movement of goods is direct.
  • Advantages
  • Managing foreign exchange exposure is centrally
    located for all subsidiaries allowing center to
    attain specialized expertise
  • Guaranteeing the exchange rate for future orders
    can be done through the center by setting firm
    local currency costs in advance
  • Managing intra-subsidiary cash flows, including
    leads and lags of payments is better managed and
    allows center to hedge only the net exposure of
    cash flows
  • Disadvantage that the cost of center may be
    greater than the benefits attained.

13
Working Capital Management
  • The operating cycle of a business generates
    funding needs, cash inflows and outflows the
    cash conversion cycle and foreign exchange rate
    and credit risks.
  • The funding needs generated by operations of the
    firm constitute working capital.
  • The cash conversion cycle is the period of time
    extending between cash outflows for purchased
    inputs and cash inflow from cash settlement.
  • The entire process from stage t0 to t5 is the
    companys operating cycle.

14
The Operating Cycle
15
Working Capital Funding
  • Net Working Capital (NWC) is the net investment
    required of the firm to support on-going sales.
    NWC components typically grow as the firm buys
    inputs, produces product, and sells finished
    goods.
  • Days working capital is a common method used to
    calculate the NWC of a firm
  • This method is based on using a days sales
    basis if the value of A/R, inventories and A/P
    are divided by the annual daily sales
  • The firms NWC can be summarized in the number of
    days sales of NWC. These results vary among
    industries and countries.

16
Working Capital Financing
  • Managing Receivables
  • A firms operating cash inflow is derived
    primarily from the collection of receivables
  • There are several factors that go into the
    management of receivables
  • Independent customers requires decisions about
    currency of denomination and payments terms
  • Payment terms
  • Self-liquidating bills secured by physical
    inventory that has been sold and the funds are
    lent based on the securitization
  • Other terms
  • Inventory Management
  • Anticipating devaluation management must decide
    whether to build inventory of items that carry
    foreign exchange exposure
  • Anticipating price freezes

17
International Cash Management
  • International cash management is the set of
    activities determining the levels of cash
    balances held throughout the MNE, cash
    management, and the facilitation of its movement
    cross border, settlements and processing
  • Cash levels are determined independently of
    working capital management decisions
  • Cash balances, including marketable securities,
    are held partly for day-to-day transactions
    (transaction motive) and to protect against
    unanticipated variations from budgeted cash flows
    (precautionary motive)
  • Cash disbursed for operations is replenished from
    two sources
  • Internal working capital turnover
  • External sourcing, traditionally short-term
    borrowing

18
International Cash Management
  • All firms engage in some sort form of the
    following steps
  • Planning a financial manager anticipates cash
    flows over future days, weeks, or months.
  • Collection controlled through time lags between
    the shipment date and the payment date.
  • Disbursement steps included are avoiding
    unnecessary early payment, maximizing float and
    selecting a disbursement bank.
  • Covering cash shortages anticipated cash
    shortages can be managed by borrowing locally.
  • Investing surplus cash if a subsidiary of an
    MNE generates surplus cash, the MNE must decide
    whether to handle its own short-term liquidity or
    whether surplus funds should be controlled
    centrally.

19
International Cash Settlements
  • Four techniques for simplifying and lowering the
    cost of settling cash flows between related and
    unrelated firms
  • Wire transfers Variety of methods but two most
    popular for cash settlements are CHIPS and SWIFT
  • Cash pooling
  • Payment netting
  • Electronic fund transfers

20
International Cash Settlements
  • Cash Pooling and Centralized Depositories
  • Businesses with widely dispersed operating
    subsidiaries can gain operational benefits by
    centralizing cash management.
  • Subsidiaries hold minimum cash for their own
    transactions and no cash for precautionary
    purposes.
  • All excess funds are remitted to a central cash
    depository.
  • Information advantage is attained by central
    depository on currency movements and interest
    rate risk.
  • Precautionary balance advantages as MNE can
    reduce pool without any loss in level of
    protection.

21
International Cash Settlements
  • Multilateral Netting
  • Defined as the process that cancels via offset
    all, or part, of the debt owed by one entity to
    another related entity.
  • Netting of payments is useful primarily when a
    large number of separate foreign exchange
    transactions occur between subsidiaries.

22
Financing Working Capital
  • All firms need to finance working capital and
    most of the short-term financing needs is done
    through the use of bank credit lines.
  • Banking sources available to MNEs are
  • In-house Banks set of functions performed by
    the existing treasury department, providing
    banking services to the various units of the
    firm.
  • Commercial Banking Offices
  • Correspondent Banks with local banks across the
    world
  • Representative Offices established in a foreign
    country
  • Branch Banks and Affiliates
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