Financial Management in the International Business

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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

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

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

regulations concerning the flow of capital across borders

norms regarding the financing of business activities

currencies

tax regimes

levels of economic and political risk

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)

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

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. Discuss of the economic theory of foreign direct Investment. We looked at the political economy of foreign direct investment and considered the role that government intervention can play in foreign Investment.

CH7 CH8

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.

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

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

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

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

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

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

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

Financing Decisions and The Global Capital Market

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/depreciation) influences capital and financing decisions

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

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

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

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

Dividend Remittances
Most common method of transfer
Dividend varies with:
Tax regulations

Foreign exchange risk

Age of subsidiary Extent of local equity participation

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

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

Benefits of Manipulating Transfer 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

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

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

Tax Advantages of Fronting Loans

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.

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

(Netting Center)

Techniques for Global Money Management --Centralized depositories

Square root of ($1,000,000+2,000,000+3,000,000) = Square root of 14,000,000 =$3,741,657 $28 million+(3* $3,741,657) =$39,224,971 $46 million $39,224,971=$6,775,029

Techniques for Global Money Management --Multilateral Netting

Bilateral netting
$4million

French subsidiary
$2 million

$6 million

Mexican subsidiary

Multilateral netting simply extending the bilateral concept to multiple subsidiaries within an international business

Techniques for Global Money Management --Multilateral Netting

Techniques for Global Money Management --Multilateral Netting

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

Case1- Introduction of company

Procter & Gamble (P&G) is the largest U.S. consumer products company. P&G manufactures and markets more than 200 products that it sells in 130 countries. Unilever P&G is a dominant global force in laundry detergents, clearing products, personal care products, and pet food products.

Case1- Company failure

By 1985, after 13 years in Japan, P&G 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, P&G introduced its Cheer laundry detergent in Japan, but the advertisement is wrong.

Case1- Products succeed

P&G 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.

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.

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.

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.

Thank you for your listening