13 Direct Foreign Investment
Chapter Objectives
▪ Describe common motives for initiating foreign
direct investment
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Motives for Direct Foreign Investment
Revenue-Related Motives
▪ Attract new sources of demand
MNCs commonly pursue DFI in countries experiencing economic
growth so that they can benefit from the increased demand for
products and services there.
▪ Enter profitable markets
When similar industries are generating very high earnings in a
particular country, an MNC may decide to sell its own products in
those markets.
▪ Exploit monopolistic advantages
Firms possessing resources or skills not available to competing firms
may attempt to exploit it internationally.
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Motives for Direct Foreign Investment
Revenue-Related Motives (cont.)
▪ React to trade restrictions
MNCs may pursue DFI to circumvent trade barriers.
▪ Diversify Internationally
By diversifying sales (and possibly even production)
internationally, a firm can make its net cash flows less volatile.
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Motives for Direct Foreign Investment
Cost Related Motives
▪ Fully benefit from economies of scale
Lower average cost per unit resulting from increased production.
▪ Use foreign factors of production
Labor and land costs can vary dramatically among countries.
▪ Use foreign raw materials
Develop the product in the country where the raw materials are
located.
▪ Use foreign technology
▪ React to exchange rate movements
When a firm perceives that a foreign currency is undervalued, the
firm may consider DFI in that country, as the initial outlay should be
relatively low.
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Exhibit 13.1 Summary of Motives for Direct Foreign
Investment
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Benefits of International Diversification
Select foreign projects whose performance levels are not
highly correlated over time. (Exhibit 13.3)
p2 = wA2 A2 + wB2 B2 + 2 wA wB A B CORRAB
w = proportion of total funds in investments A or B
σ = standard deviation of returns on investments A or B
CORR = correlation coefficient of returns A and B
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Exhibit 13.3 Evaluation of Proposed Projects in Alternative
Locations
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Benefits of International Diversification
Diversification Analysis of International Projects
▪ Comparing portfolios along the frontier of efficient projects
(See Exhibit 13.4)
▪ Comparing frontiers among MNCs (See Exhibit 13.5)
Diversification Among Countries
▪ Exhibit 13.6 shows how the stock market values of various
countries have changed over time.
▪ A country’s stock market value reflects the expectations of
business opportunities and economic growth.
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Exhibit 13.4 Risk-Return Analysis of International Projects
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Exhibit 13.5 Risk-Return Advantage of a Diversified MNC
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Host Government Views of DFI
Incentives to encourage DFI
▪ The ideal DFI solves problems such as unemployment and lack of
technology without taking business away from local firms.
▪ Governments are particularly willing to offer incentives for DFI that
will result in the employment of local citizens or an increase in
technology.
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Host Government Views of DFI
Barriers to DFI
▪ Protective barriers - agencies may prevent an MNC from
acquiring companies if they believe employees will be laid off.
▪ Red tape barriers - procedural and documentation requirements
▪ Industry barriers - local firms may have substantial influence
on the government and may use their influence to prevent
competition from MNCs
▪ Environmental barriers - building codes, disposal of
production waste materials, and pollution controls.
▪ Regulatory barriers - each country enforces its own regulatory
constraints pertaining to taxes, currency convertibility, earnings
remittance, employee rights, and other policies
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Host Government View of DFI (Cont.)
Barriers to DFI
▪ Ethical differences - a business practice that is perceived to
be unethical in one country may be ethical in another.
▪ Political instability - if a country is susceptible to abrupt
changes in government and political conflicts, the feasibility of
DFI may be dependent on the outcome of those conflicts.
Government-imposed conditions to engage in DFI
▪ Some governments allow international acquisitions but impose
special requirements on MNCs that desire to acquire a local firm.
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