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Financial Management in the International Business

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Title: Financial Management in the International Business


1
Financial Management in the International Business
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2
Index
  • Introduction
  • Investment Decisions
  • Financing Decisions
  • Global Money ManagementThe Efficiency Objective
  • Global Money ManagementThe Tax Objective
  • Moving Money across BordersAttaining
    Efficiencies and Reducing Taxes
  • Techniques for Global Money Management
  • Cases

3
Introduction
  • Scope of financial management includes three sets
    of related decisions
  • Investment decisions
  • Decisions about what activities to finance
  • Financing decisions
  • Decisions about how to finance those activities
  • Money management decisions
  • Decisions about how to manage the firms
    financial resources most efficiently

4
Introduction
  • In an international business, investment,
    financing, and money management decisions are
    complicated by different

norms regarding the financing of business
activities
regulations concerning the flow of capital
across borders
tax regimes
levels of economic and political risk
currencies
5
Introduction
  • Financial managers must consider
  • 1. when deciding which activities to finance
  • 2. how best to finance those activities
  • 3. how best to manage the firms financial
    resources
  • 4. how best to protect the firm from political
    and economic risks (including foreign exchange
    risk)

6
Investment Decisions
  • Capital budgeting
  • Project and Parent Cash Flows
  • Adjusting for Political and Economic Risk

7
Review
CH2 CH3 Discuss how the political, economic ,legal, and cultural environment of a country can influence the benefits, costs and risks of doing business there and thus its attractiveness as an investment site.
CH7 Discuss of the economic theory of foreign direct Investment.
CH8 We looked at the political economy of foreign direct investment and considered the role that government intervention can play in foreign Investment.
CH12 We pulled much of this material together when we considered how a firm can reduce its costs of value creation and / or increase its value added by investing in productive activities in other countries.
CH14 We considered the various models for entering foreign markets.
8
Capital budgeting
  • Capital budgeting
  • Quantifies the benefits, costs and risks of an
    investment
  • Managers can reasonably compare different
    investment alternatives within and across
    countries
  • Complicated process

Identification
Selection
Follow-up
Development
Implementation
9
Project and Parent Cash Flows
  • Project cash flows may not reach the parent
  • Host country may block cash-flow repatriation
  • Cash flows may be taxed at an unfavorable rate
  • Host government may require a percentage of cash
    flows to be reinvested in the host country

10
Adjusting for Political and Economic Risk
  • Political risk
  • Expropriation - Iranian revolution, 1979
  • Social unrest - after the breakup of Yugoslavia,
    company assets were rendered worthless
  • Political change - may lead to tax and ownership
    changes
  • Collapse of communism in Eastern Europe
  • Attack on the World Trade Center
  • Economic risk
  • Inflation

11
Financing Decisions
  • How the foreign investment will be financed
  • How the financial structure of the foreign
    affiliate should be configured

12
Financing Decisions and The Global Capital Market
  • A capital market brings together those who want
    to invest money and those who want to borrow
    money
  • Those who want to invest money include
  • Corporations
  • Individuals
  • Non-bank financial institutions
  • Those who want to borrow money include
  • Individuals
  • Companies
  • Governments

13
Financing Decisions and The Global Capital Market
  • Capital market loans to corporations are either
  • Equity loans occur when corporations sell stock
    to investors
  • Debt loans occur when a corporation borrows money
    and agrees to repay a predetermined portion of
    the loan amount at regular intervals regardless
    of how much profit it is making

14
Financing Decisions and The Global Capital Market
  • Cost of capital is the price of borrowing money,
    which is the rate of return that borrowers must
    pay investors
  • In a purely domestic capital market the pool of
    investors is limited to residents of the country
  • Places an upper limit on the supply of funds
    available
  • Increases the cost of capital
  • A global capital market provides a larger supply
    of funds for borrowers to draw on
  • Lowers the cost of capital

15
Financing Decisions and The Global Capital Market
16
Source of Financing
  • Global capital markets for lower cost financing.
  • Impact of host country - may require projects to
    be locally financed through debt or equity
  • Limited liquidity raises the cost of capital
  • Host government may offer low interest or
    subsidized loans to attract investment
  • Impact of local currency (appreciation/depreciatio
    n)
  • influences capital and financing decisions

17
Financial Structure
  • Financial structure
  • Follow local capital structure norms?
  • More easily evaluate return on equity relative to
    local competition
  • Good for companys image
  • Best recommendation adopt a financial structure
    that minimizes the cost of capital

18
Global Money Management -The Efficiency
Objective
  • Minimizing cash balances
  • Money market accounts - low interest - high
    liquidity
  • Certificates of deposit - higher interest - lower
    liquidity
  • Reducing transaction costs (cost of exchange)
  • Transaction costs changing from one currency to
    another
  • Transfer fee fee for moving cash from one
    location to another

19
Global Money Management - The Tax Objective
  • Countries tax income earned outside their
    boundaries by entities based in their country
  • Can lead to double taxation
  • Tax credit allows entity to reduce home taxes by
    amount paid to foreign government
  • Tax treaty is an agreement between countries
    specifying what items will be taxed by
    authorities in country where income is earned
  • Deferral principle specifies that parent
    companies will not be taxed on foreign income
    until the dividend is received
  • Tax haven is used to minimize tax liability

20
Moving Money Across Borders Attaining
Efficiencies and Reducing Taxes
  • Unbundling A mix of techniques to transfer
    liquid funds from a foreign subsidiary to the
    parent company without piquing the host country
  • Dividend remittances
  • Royalty payments and fees
  • Transfer Prices
  • Fronting loans
  • Selecting a particular policy is limited when a
    foreign subsidiary is part owned by a local
    joint-venture partner or local stockholders

21
Dividend Remittances
  • Most common method of transfer
  • Dividend varies with
  • Tax regulations
  • Foreign exchange risk
  • Age of subsidiary
  • Extent of local equity participation

22
Royalty Payments and Fees
  • Royalties represent the remuneration paid to
    owners of technology, patents or trade names for
    their use by the firm
  • Common for parent to charge a subsidiary for
    technology, patents or trade names transferred to
    it
  • May be levied as a fixed amount per unit sold or
    percentage of revenue earned
  • Fees are compensation for professional services
    or expertise supplied to subsidiary
  • Management fees or technical assistance fees
  • Fixed charges for services provided

23
Transfer Prices
  • Price at which goods or services are transferred
    within a firms entities
  • Position funds within a company
  • Move founds out of country by setting high
    transfer fees or into a country by setting low
    transfer fees
  • Movement can be within subsidiaries or between
    the parent and its subsidiaries

24
Benefits of ManipulatingTransfer Prices
  • Reduce tax liabilities by using transfer fees to
    shift from a high-tax country to a low-tax
    country
  • Reduce foreign exchange risk exposure to expected
    currency devaluation by transferring funds
  • Can be used where dividends are restricted or
    blocked by host-government policy
  • Reduce import duties (ad valorem) by reducing
    transfer prices and the value of the goods

25
Problems With Transfer Pricing
  • Few governments like it
  • Believe (rightly) that they are losing revenue
  • Has an impact on management incentives and
    performance evaluations
  • Inconsistent with a profit center
  • Managers can hide inefficiencies

26
Fronting Loans
  • Loan between a parent and subsidiary is channeled
    through a financial intermediary (bank)
  • Allows circumvention of host country restrictions
    on remittance of funds from subsidiary to parent
  • Provides certain tax advantages

27
Tax Advantages of Fronting Loans
28
Techniques for Global Money Management
  • Firms use two money management techniques in
    attempting to manage their global cash resources
    in the most efficient manner centralized
    depositories and multilateral netting.

29
Techniques for Global Money Management
--Centralized depositories
  • Need cash reserves to service accounts and
    insuring against negative cash flows
  • Should each subsidiary hold its own cash balance?
  • By pooling, firm can deposit larger cash amounts
    and earn higher interest rates
  • If located in a major financial center, can get
    information on good investment opportunities
  • Can reduce the total size of cash pool and invest
    larger reserves in higher paying, long term,
    instruments
  • Cash Budget report
  • Netting Center

30
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31
Techniques for Global Money Management
--Centralized depositories
  • Square root of (1,000,000²2,000,000²3,000,000²)
  • Square root of 14,000,000
  • 3,741,657
  • 28 million(3 3,741,657) 39,224,971
  • 46 million- 39,224,9716,775,029

32
Techniques for Global Money Management
--Multilateral Netting
  • Bilateral netting
  • Multilateral netting simply extending the
    bilateral concept to multiple subsidiaries within
    an international business

4million
French subsidiary
Mexican subsidiary
6 million
2 million
33
Techniques for Global Money Management
--Multilateral Netting
34
Techniques for Global Money Management
--Multilateral Netting
35
Cash Flows After Multilateral Netting
  • If the transaction costs is 1
  • Before multilateral netting, transaction costs is
    430,000 (43 million 1)
  • After multilateral netting, transaction costs is
    50,000 (5 million 1)
  • A saving of 380,000 achieved through
    multilateral netting

36
Case1- Introduction of company
  • Procter Gamble (PG) is the largest U.S.
  • consumer products company.
  • PG manufactures and markets more than 200
    products that it sells in 130 countries.
  • Unilever PG is a dominant global force in
    laundry detergents, clearing products, personal
    care products, and pet food products.

37
Case1- Company failure
  • By 1985, after 13 years in Japan, PG was still
    losing 40 million a year there.
  • It had introduced disposable diapers in Japan and
    only held 8 share of market.
  • In the early 1980s, PG introduced its Cheer
    laundry detergent in Japan, but the advertisement
    is wrong.

38
Case1- Products succeed
  • PG experience with disposable diapers and
    laundry detergents in Japan forced the company to
    rethink its product development and marketing
    philosophy.
  • Succeed brain Joy (dish soap.)
  • New laundry detergent.

39
Case2- Introduction of company
  • Merrill Lynch is a investment banking, also the
    largest underwriter of debt and equity and the
    third largest mergers and acquisitions adviser.
  • Merrill Lynch started a private client business
    in Japan in 1980s but met with limited success.

40
Case2- Company failure in Japan
  • Because Japans big four stockbrokerages, which
    traditionally had monopolized the Japanese
    market.
  • Restrictive regulations made it almost impossible
    for Merrill Lynch to offer private clients.

41
Case2- Reentry Japan
  • In the mid-1990s, Japan embarked on a
    wide-ranging deregulation of its financial
    services industry.
  • The company initially considered a joint venture
    with Sanwa Bank to sell Merrill Lynchs mutual
    fund products.
  • The best way to enter the Japanese market is
    acquired Yamaichi Securities which is bankrupt.

42
  • Thank you for your listening
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