International Financial Management Jeff Madura 8th -IM-ch01

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Answer for International Financial Management Jeff Madura 8th

    Chapter 1

    Multinational Financial Management: An Overview

Lecture Outline

Goal of the MNC

     Conflicts with the MNC Goal

     Impact of Management Control

     Impact of Corporate Control

     Constraints Interfering with the MNC’s Goal

Theories of International Business

     Theory of Comparative Advantage

     Imperfect Markets Theory

     Product Cycle Theory

    International Business Methods

     International Trade



     Joint Ventures

     Acquisitions of Existing Operations

     Establishing New Foreign Subsidiaries

International Opportunities

     Investment Opportunities

     Financing Opportunities

     Opportunities in Europe

     Opportunities in Latin America

     Opportunities in Asia

Exposure to International Risk

     Exposure to Exchange Rate Movements

     Exposure to Foreign Economies

     Exposure to Political Risk

Overview of an MNC’s Cash Flows

    Valuation Model for an MNC


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    Chapter Theme

    This chapter introduces the multinational corporation as having similar goals to the purely domestic corporation, but a wider variety of opportunities. With additional opportunities come potential increased returns and other forms of risk to consider. The potential benefits and risks are introduced.

Topics to Stimulate Class Discussion

1. What is the appropriate definition of an MNC?

2. Why does an MNC expand internationally?

3. What are the risks of an MNC which expands internationally?

4. Why do you think European countries attract U.S. firms?

5. Why must purely domestic firms be concerned about the international environment?


    Should an MNC Reduce Its Ethical Standards to Compete Internationally?

    POINT: Yes. When a U.S.-based MNC competes in some countries, it may encounter some business norms there that are not allowed in the U.S. For example, when competing for a government contract, firms might provide payoffs to the government officials who will make the decision. Yet, in the United States, a firm will sometimes take a client on an expensive golf outing or provide skybox tickets to events. This is no different than a payoff. If the payoffs are bigger in some foreign countries, the MNC can compete only by matching the payoffs provided by its competitors.

    COUNTER-POINT: No. A U.S.-based MNC should maintain a standard code of ethics that applies to any country, even if it is at a disadvantage in a foreign country that allows activities that might be viewed as unethical. In this way, the MNC establishes more credibility worldwide.

    WHO IS CORRECT? Use InfoTrac or some other search engine to learn more about this issue. Which argument do you support? Offer your own opinion on this issue.

    ANSWER: The issue is frequently discussed. It is easy to suggest that the MNC should maintain a standard code of ethics, but in reality, that means that it will not be able to compete in some cases. For example, even if it submits the lowest bid on a specific foreign government project, it will not receive the bid without a payoff to the foreign government officials. The issue is especially a concern for large projects that may generate substantial cash flows for the firm that is chosen to do the project. Ideally, the MNC can clearly demonstrate to whoever oversees the decision process that it deserves to be selected. If there is just one decision-maker with no oversight, an MNC can not ensure that the decision will be ethical. But if the decision-maker must be accountable to a department who oversees the decision, the MNC may be able to prompt the department to ensure that the process is ethical.

Chapter 1: Multinational Financial Management: An Overview 3

    Answers to End of Chapter Questions

1. Agency Problems of MNCs.

    a. Explain the agency problem of MNCs.

     ANSWER: The agency problem reflects a conflict of interests between decision-making managers

    and the owners of the MNC. Agency costs occur in an effort to assure that managers act in the best

    interest of the owners.

    b. Why might agency costs be larger for an MNC than for a purely domestic firm?

     ANSWER: The agency costs are normally larger for MNCs than purely domestic firms for the

    following reasons. First, MNCs incur larger agency costs in monitoring managers of distant foreign

    subsidiaries. Second, foreign subsidiary managers raised in different cultures may not follow

    uniform goals. Third, the sheer size of the larger MNCs would also create large agency problems.

2. Comparative Advantage.

    a. Explain how the theory of comparative advantage relates to the need for international business.

     ANSWER: The theory of comparative advantage implies that countries should specialize in

    production, thereby relying on other countries for some products. Consequently, there is a need for

    international business.

     b. Explain how the product cycle theory relates to the growth of an MNC.

     ANSWER: The product cycle theory suggests that at some point in time, the firm will attempt to

    capitalize on its perceived advantages in markets other than where it was initially established.

3. Imperfect Markets.

    a. Explain how the existence of imperfect markets has led to the establishment of subsidiaries in

    foreign markets.

     ANSWER: Because of imperfect markets, resources cannot be easily and freely retrieved by the

    MNC. Consequently, the MNC must sometimes go to the resources rather than retrieve resources

    (such as land, labor, etc.).

    b. If perfect markets existed, would wages, prices, and interest rates among countries be more

    similar or less similar than under conditions of imperfect markets? Why?

     ANSWER: If perfect markets existed, resources would be more mobile and could therefore be

    transferred to those countries more willing to pay a high price for them. As this occurred, shortages

    of resources in any particular country would be alleviated and the costs of such resources would be

    similar across countries.

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    4. International Opportunities.

     a. How does access to international opportunities affect the size of corporations?

     ANSWER: Additional opportunities will often cause a firm to grow more than if it did not have

    access to such opportunities. Thus, a firm that considers international opportunities has greater

    potential for growth.

    b. Describe a scenario in which the size of a corporation is not affected by access to international


     ANSWER: Some firms may avoid opportunities because they lack knowledge about foreign

    markets or expect that the risks are excessive. Thus, the size of these firms is not affected by the


     c. Explain why MNCs such as Coca Cola and PepsiCo, Inc., still have numerous opportunities for

    international expansion.

     ANSWER: Coca Cola and PepsiCo still have new international opportunities because countries are

    at various stages of development. Some countries have just recently opened their borders to MNCs.

    Many of these countries do not offer sufficient food or drink products to their consumers.

5. International Opportunities Due to the Internet.

    a. What factors cause some firms to become more internationalized than others?

     ANSWER: The operating characteristics of the firm (what it produces or sells) and the risk

    perception of international business will influence the degree to which a firm becomes

    internationalized.Several other factors such as access to capital could also be relevant here. Firms

    that are labor-intensive could more easily capitalize on low-wage countries while firms that rely on

    technological advances could not.

    b. Offer your opinion on why the Internet may result in more international business.

    ANSWER: The Internet allows for easy and low-cost communication between countries, so that

    firms could now develop contacts with potential customers overseas by having a website. Many

    firms use their website to identify the products that they sell, along with the prices for each product.

    This allows them to easily advertise their products to potential importers anywhere in the world

    without mailing brochures to various countries. In addition, they can add to their product line and

    change prices by simply revising their website, so importers are kept abreast of the exporter’s

    product information by monitoring the exporter’s website periodically. Firms can also use their

    websites to accept orders online. Some firms with an international reputation use their brand name

    to advertise products over the internet. They may use manufacturers in some foreign countries to

    produce some of their products subject to their specification

Chapter 1: Multinational Financial Management: An Overview 5

    6. Impact of the Euro. Explain how the adoption of the euro as the single currency by European

    countries could be beneficial to MNCs based in Europe and to MNCs based in the U.S.

     ANSWER: There is now no exchange rate risk between the countries participating in the euro.

    This makes it easier to compare prices across countries and to compete for MNCs based in Europe.

    The advantages are the same for MNCs based in the U.S.

7. Benefits and Risks of International Business. As an overall review of this chapter, identify

    possible reasons for growth in international business. Then, list the various disadvantages that may

    discourage international business.

     ANSWER: Growth in international business can be stimulated by (1) access to foreign resources

    which can reduce costs, or (2) access to foreign markets which boost revenues. Yet, international

    business is subject to risks of exchange rate fluctuations, foreign exchange restrictions, a host

    government takeover, tax regulations, etc.

8. Motives of an MNC. Describe constraints that interfere with an MNC’s objective.

     ANSWER: The constraints faced by financial managers attempting to maximize shareholder

    wealth are:

     a. Environmental constraintscountries impose environmental regulations such as building codes

    and pollution controls, which increase costs of production.

    b. Regulatory constraintshost governments can impose taxes, restrictions on earnings

    remittances, and restrictions on currency convertibility, which may reduce cash flows to be

    received by the parent.

     c. Ethical constraintsU. S.-based MNCs may be at a competitive disadvantage if they follow a

    worldwide code of ethics, because other firms may use tactics that are allowed in some foreign

    countries but considered illegal by U. S. standards.

9. Centralization and Agency Costs. Would the agency problem be more pronounced for Berkley

    Corp., which has its parent company make most major decisions for its foreign subsidiaries, or

    Oakland Corp., which uses a decentralized approach?

     ANSWER: The agency problem would be more pronounced for Oakland because of a higher

    probability that subsidiary decisions would conflict with the parent. Assuming that the parent

    attempts to maximize shareholder wealth, decisions by the parent should be compatible with

    shareholder objectives. If the subsidiaries made their own decisions, the agency costs would be

    higher since the parent would need to monitor the subsidiaries to assure that their decisions were

    intended to maximize shareholder wealth.

    10. Global Competition. Explain why more standardized product specifications across countries can

    increase global competition.

     ANSWER: Standardized product specifications allow firms to more easily expand their business

    across other countries, which increases global competition.

6 International Financial Management

    11. Impact of the Euro on U.S. Subsidiaries. McCanna Corp. has a French subsidiary that produces

    wine and exports to various European countries. Explain how the subsidiary’s business may have

    been affected since the conversion of many European currencies into a single European currency

    (the euro) in 1999.

     ANSWER: The subsidiary and its customers based in countries that now use the euro as their

    currency would no longer be exposed to exchange rate risk.

12. Macro versus Micro Topics. Review the table of contents and indicate whether each of the

    chapters from Chapter 2 through Chapter 21 has a macro or micro perspective.

     ANSWER: Chapters 2 through 8 are macro, while Chapters 9 through 21 are micro.

13. Methods Used to Conduct International Business. Duve, Inc., desires to penetrate a foreign

    market with either a licensing agreement with a foreign firm or by acquiring a foreign firm. Explain

    the differences in potential risk and return between a licensing agreement with a foreign firm, and

    the acquisition of a foreign firm.

     ANSWER: A licensing agreement has limited potential for return, because the foreign firm will

    receive much of the benefits as a result of the licensing agreement. Yet, the MNC has limited risk,

    because it did not need to invest substantial funds in the foreign country.

     An acquisition by the MNC requires a substantial investment. If this investment is not a success,

    the MNC may have trouble selling the firm it acquired for a reasonable price. Thus, there is more

    risk. However, if this investment is successful, all of the benefits accrue to the MNC.

    14. International Business Methods. Snyder Golf Co., a U.S. firm that sells high-quality golf clubs in

    the U.S., wants to expand internationally by selling the same golf clubs in Brazil.

    a. Describe the tradeoffs that are involved for each method (such as exporting, direct foreign

    investment, etc.) that Snyder could use to achieve its goal.

    ANSWER: Snyder can export the clubs, but the transportation expenses may be high. If could

    establish a subsidiary in Brazil to produce and sell the clubs, but this may require a large

    investment of funds. It could use licensing, in which it specifies to a Brazilian firm how to produce

    the clubs. In this way, it does not have to establish its own subsidiary there.

     b. Which method would you recommend for this firm? Justify your recommendation.

    ANSWER: If the amount of golf clubs to be sold in Brazil is small, it may decide to export.

    However, if the expected sales level is high, it may benefit from licensing. If it is confident that the

    expected sales level will remain high, it may be willing to establish a subsidiary. The wages are

    lower in Brazil, and the large investment needed to establish a subsidiary may be worthwhile.

15. Impact of Political Risk. Explain why political risk may discourage international business.

    ANSWER: Political risk increases the rate of return required to invest in foreign projects. Some

    foreign projects would have been feasible if there was no political risk, but will not be feasible

    because of political risk.

Chapter 1: Multinational Financial Management: An Overview 7

    16. Impact of September 11. Following the terrorist attack on the U.S., the valuations of many MNCs

    declined by more than 10 percent. Explain why the expected cash flows of MNCs were reduced,

    even if they were not directly hit by the terrorist attacks.

    ANSWER: An MNC’s cash flows could be reduced in the following ways. First, a decline in

    travel would affect any MNCs that have business in travel-related industries. The airline, hotel, and

    tourist-related industries were expected to experience a decline in business. Layoffs were announced

    immediately by many of these MNCs. Second, these effects on travel-related industries can carry

    over to other industries, and weaken economies. Third, the cost of international trade increased as a

    result of tighter restrictions on some products. Fourth, some MNCs incurred expenses as a result of

    increasing security to protect their employees.

    Advanced Questions

17. International Joint Venture. Anheuser-Busch, the producer of Budweiser and other beers, has

    recently expanded into Japan by engaging in a joint venture with Kirin Brewery, the largest brewery

    in Japan. The joint venture enables Anheuser-Busch to have its beer distributed through Kirin’s

    distribution channels in Japan. In addition, it can utilize Kirin’s facilities to produce beer that will

    be sold locally. In return, Anheuser-Busch provides information about the American beer market to


    a. Explain how the joint venture can enable Anheuser-Busch to achieve its objective of

    maximizing shareholder wealth.

     ANSWER: The joint venture creates a way for Anheuser-Busch to distribute Budweiser throughout

    Japan. It enables Anheuser-Busch to penetrate the Japanese market without requiring a substantial

    investment in Japan.

     b. Explain how the joint venture can limit the risk of the international business.

     ANSWER: The joint venture has limited risk because Anheuser-Busch does not need to establish

    its own distribution network in Japan. Thus, Anheuser-Busch may be able to use a smaller

    investment for the international business, and there is a higher probability that the international

    business will be successful.

     c. Many international joint ventures are intended to circumvent barriers that normally prevent

    foreign competition. What barrier in Japan is Anheuser-Busch circumventing as a result of the

    joint venture? What barrier in the United States is Kirin circumventing as a result of the joint


     ANSWER: Anheuser-Busch is able to benefit from Kirin’s distribution system in Japan, which

    would not normally be so accessible. Kirin is able to learn more about how Anheuser-Busch

    expanded its product across numerous countries, and therefore breaks through an “information”


     d. Explain how Anheuser-Busch could lose some of its market share in countries outside Japan as

    a result of this particular joint venture.

8 International Financial Management

     ANSWER: Anheuser-Busch could lose some of its market share to Kirin as a result of explaining

    its worldwide expansion strategies to Kirin. However, it appears that Anheuser-Busch expects the

    potential benefits of the joint venture to outweigh any potential adverse effects.

18. Impact of Eastern European Growth. The managers of Loyola Corp. recently had a meeting to

    discuss new opportunities in Europe as a result of the recent integration among Eastern European

    countries. They decided not to penetrate new markets because of their present focus on expanding

    market share in the United States. Loyola’s financial managers have developed forecasts for

    earnings based on the 12 percent market share (defined here as its percentage of total European

    sales) that Loyola currently has in Eastern Europe. Is 12 percent an appropriate estimate for next

    year’s Eastern European market share? If not, does it likely overestimate or underestimate the

    actual Eastern European market share next year?

     ANSWER: It would likely overestimate its market share because the competition should increase

    as competitors penetrate the European countries.

    19. Valuation of an MNC. Birm Co., based in Alabama, considers several international opportunities

    in Europe that could affect the value of its firm. The valuation of its firm is dependent on four

    factors: (1) expected cash flows in dollars, (2) expected cash flows in euros that are ultimately

    converted into dollars, (3) the rate at which it can convert euros to dollars, and (4) Birm’s weighted

    average cost of capital. For each opportunity, identify the factors that would be affected.

    a. Birm plans a licensing deal in which it will sell technology to a firm in Germany for $3,000,000;

    the payment is invoiced in dollars, and this project has the same risk level as its existing


    b. Birm plans to acquire a large firm in Portugal that is riskier than its existing businesses.

    c. Birm plans to discontinue its relationship with a U.S. supplier so that can import a small

    amount of supplies (denominated in euros) at a lower cost from a Belgian supplier.

    d. Birm plans to export a small amount of materials to Ireland that are denominated in euros.


Opportunity Dollar CF Euro CF Exchange rate at Birmingham’s

    which Birm Co. weighted average

    converts euros to cost of capital


    a. joint venture X

    b. acquisition X X

    c. imported X


    d. exports to X


20. Assessing Motives for International Business. Fort Worth Inc. specializes in manufacturing some

    basic parts for sports utility vehicles that are produced and sold in the U.S. Its main advantage in

    the U.S. is that its production is efficient, and less costly than that of some other unionized

    manufacturers. It has a substantial market share in the U.S. Its manufacturing process is labor-

    intensive. It pays relatively low wages compared to U.S. competitors, but has guaranteed the local

    Chapter 1: Multinational Financial Management: An Overview 9

    workers that their job positions will not be eliminated for the next 30 years. It hired a consultant to determine whether it should set up a subsidiary in Mexico, where the parts would be produced. The consultant suggested that Forth Worth should expand for the following reasons. Offer your opinion on whether the consultant’s reasons are logical:

    a. Theory of Competitive Advantage: There are not many SUVs sold in Mexico, so Fort Worth

    Inc. would not have to face much competition there.

    b. Imperfect Markets Theory: Fort Worth Inc. can not easily transfer workers to Mexico, but it

    can establish a subsidiary there in order to penetrate a new market.

    c. Product Cycle Theory: Fort Worth Inc. has been successful in the U.S. It has limited growth

    opportunities because it already controls much of the U.S. market for the parts it produces.

    Thus, the natural next step is to conduct the same business in a foreign country.

    d. Exchange Rate Risk. The exchange rate of the peso has weakened recently, so this would allow

    Fort Worth Inc. to build a plant at a very low cost (by exchanging dollars for the cheap pesos to

    build the plant).

    e. Political Risk. The political conditions in Mexico have stabilized in the last few months, so Fort

    Worth should attempt to penetrate the Mexican market now.

    ANSWER: None of the arguments by the consultant are logical. If SUVs are not sold in the Mexican market, there is no need for these parts in Mexico. Fort Worth Inc. should only attempt to penetrate a new market if there is demand. Just because it has limited growth potential in the U.S., this does not mean that there will be demand for its product in Mexico. Even if the exchange rate is low relative to recent periods, it could decline further, which would adversely affect any the dollar amount of future remitted earnings. Stable political conditions in Mexico are not a sufficient reason to pursue direct foreign investment there.

    21. Valuation of Wal-Mart’s International Business. In addition to all of its stores in the U.S., Wal-

    Mart has 11 stores in Argentina, 24 stores in Brazil, 214 stores in Canada, 29 stores in China, 92 stores in Germany, 15 stores in South Korea, 611 stores in Mexico, and 261 stores in the U.K. Consider the value of Wal-Mart as being composed of two parts, a U.S. part (due to business in the U.S.) and a non-U.S. part (due to business in other countries). Explain how to determine the present value (in dollars) of the non-U.S. part assuming that you had access to all the details of Wal-Mart businesses outside the U.S.

    ANSWER: The non-U.S. part can be measured as the present value of future dollar cash flows resulting from the non-U.S. businesses. Based on recent earnings data for each store and applying an expected growth rate, you can estimate the remitted earnings that will come from each country in each year in the future. You can convert those cash flows to dollars using a forecasted exchange rate per year. Determine the present value of cash flows of all stores within one country. Then repeat the process for other countries. Then add up all the present values that you estimated to derive a consolidated present value of all non-U.S. subsidiaries.

    22. Impact of International Business on Cash Flows and Risk. Nantucket Travel Agency specializes

    in tours for American tourists. Until recently, all of its business was in the U.S. It just established a subsidiary in Athens, Greece, which provides tour services in the Greek islands for American

    10 International Financial Management

    tourists. It rented a shop near the port of Athens. It also hired residents of Athens, who could speak English and provide tours of the Greek islands. The subsidiary’s main costs are rent and salaries for its employees and the lease of a few large boats in Athens that it uses for tours. American tourists pay for the entire tour in dollars at Nantucket’s main U.S. office before they depart for Greece.

    a. Explain why Nantucket may be able to effectively capitalize on international opportunities such

    as the Greek island tours.

    ANSWER: It already has established credibility with American tourists, but could penetrate a new market with some of the same customers that it has served on tours in the U.S.

    b. Nantucket is privately-owned by owners who reside in the U.S. and work in the main office.

    Explain possible agency problems associated with the creation of a subsidiary in Athens,

    Greece. How can Nantucket attempt to reduce these agency costs?

    ANSWER: The employees of the subsidiary in Athens are not owners, and may have no incentive to manage in a manner that maximizes the wealth of the owners. Thus, they may manage the tours inefficiently.

    Nantucket could attempt to allow the employees a portion of the ownership of the company so that they benefit more directly from good performance. Alternatively, Nantucket may consider having one of its owners transfer to Athens to oversee the subsidiary’s operations.

    c. Greece’s cost of labor and rent are relatively low. Explain why this information is relevant to

    Nantucket’s decision to establish a tour business in Greece.

    ANSWER: The low cost of rent and labor will be beneficial to Nantucket, because it enables Nantucket to create the subsidiary at a low cost.

    d. Explain how the cash flow situation of the Greek tour business exposes Nantucket to exchange

    rate risk. Is Nantucket favorably or unfavorably affected when the euro (Greece’s currency)

    appreciates against the dollar? Explain.

    ANSWER: Nantucket’s tour business in Greece results in dollar cash inflows and euro cash outflows. It will be adversely affected by the appreciation of the euro because it will require more dollars to cover the costs in Athens if the euro’s value rises.

    e. Nantucket plans to finance its Greek tour business. Its subsidiary could obtain loans in euros

    from a bank in Greece to cover its rent, and its main office could pay off the loans over time.

    Alternatively, its main office could borrow dollars and would periodically convert dollars to

    euros to pay the expenses in Greece. Does either type of loan reduce the exposure of Nantucket

    to exchange rate risk? Explain.

    ANSWER: No. The euro loans would be used to cover euro expenses, but Nantucket would need dollars to pay off the loans. Alternatively, the U.S. dollar loans would still require conversion of dollars to euros. With either type of loan, Nantucket is still adversely affected by the appreciation of the euro against the dollar.

    f. Explain how the Greek island tour business could expose Nantucket to country risk.

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