Copyright © 2009 Pearson Education, Inc. publishing as Prentice Hall 19-1 Part Six Managing International Operations Chapter Nineteen The Multinational Finance Function

Copyright © 2009 Pearson Education, Inc. publishing as Prentice Hall 19-2 Chapter Objectives To describe the multinational finance function and how it fits in the MNE’s organizational structure To show how companies can acquire outside funds for normal operations and expansion, including offshore debt and equity funds To explore how offshore financial centers are used to raise funds and manage cash flows To explain how companies include international factors in the capital budgeting process To discuss the major internal sources of funds available to the MNE and to show how these funds are managed globally To describe how companies protect against the major financial risks of inflation and exchange-rate movements

Copyright © 2009 Pearson Education, Inc. publishing as Prentice Hall 19-3 Factors Influencing Finance in International Business

Copyright © 2009 Pearson Education, Inc. publishing as Prentice Hall 19-4 The Role of the Treasurer in the Financial Function

Copyright © 2009 Pearson Education, Inc. publishing as Prentice Hall 19-5 The Finance Function The corporate finance function acquires and allocates financial resources among the company’s activities and projects. Four key functions are:  Capital structure.  Long-term financing.  Capital budgeting.  Working capital management. The CFO acquires financial resources and allocates them among the company’s activities and projects.

Copyright © 2009 Pearson Education, Inc. publishing as Prentice Hall 19-6 Capital Structure Capital structure of the company is the mix between long-term debt and equity Leverage is the degree to which a firm funds the growth of business by debt. The amount of leverage used varies from country to country.

Copyright © 2009 Pearson Education, Inc. publishing as Prentice Hall 19-7 Factors that Influence the Choice of Capital Structure Choice of capital structure depends on:  tax rates  degree of development of local equity markets  creditor rights Companies can use local and international debt markets to raise funds.

Copyright © 2009 Pearson Education, Inc. publishing as Prentice Hall 19-8 Global Capital Markets Two major sources of funds external to the MNE’s normal operations are debt markets and equity markets.

Copyright © 2009 Pearson Education, Inc. publishing as Prentice Hall 19-9 Eurocurrencies A Eurocurrency is any currency banked outside its country of origin, but it is primarily dollars banked outside the United States Four major sources of Eurocurrencies:  Foreign governments or individuals who want to hold dollars outside the United States  Multinational enterprises that have cash in excess of current needs  European banks with foreign currency in excess of current needs  Countries such as Germany, Japan, and Taiwan that have large balance-of-trade surpluses held as reserves

Copyright © 2009 Pearson Education, Inc. publishing as Prentice Hall International Bonds A foreign bond is one sold outside the country of the borrower but denominated in the currency of the country of issue A Eurobond, also called a global bond, is a bond issue sold in a currency other than that of the country of issue

Copyright © 2009 Pearson Education, Inc. publishing as Prentice Hall Equity Securities and the Euroequity Market The three largest stock markets in the world are in New York, Tokyo, and London, with the U.S. markets controlling nearly half of the world’s stock market capitalization. Euroequities are shares listed on stock exchanges in countries other than the home country of the issuing company

Copyright © 2009 Pearson Education, Inc. publishing as Prentice Hall American Depositary Receipts (ADRs) Most foreign companies that list on the U.S. stock exchanges do so through American Depositary Receipts, which are financial documents that represent a share or part of a share of stock in the foreign company ADRs are easier to trade on the U.S. exchanges than are foreign shares

Copyright © 2009 Pearson Education, Inc. publishing as Prentice Hall Offshore Financial Centers Offshore financing is the provision of financial services by banks and other agents to nonresidents. Offshore financial centers are cities or countries that provide large amounts of funds in currencies other than their own. OFCs offer low or zero taxation, moderate or light financial regulation, and banking secrecy and anonymity. The OECD is trying to eliminate the harmful tax practices in tax-haven countries.

Copyright © 2009 Pearson Education, Inc. publishing as Prentice Hall Capital Budgeting in a Global Context Capital budgeting is the process whereby MNEs determine which projects and countries will receive capital investment funds.

Copyright © 2009 Pearson Education, Inc. publishing as Prentice Hall Methods Of Capital Budgeting Capital budgeting techniques:  Payback period.  Net present value of a project.  Internal rate of return. MNEs need to determine free cash flows based on cash flow estimates and tax rates in different countries and an appropriate required rate of return adjusted for risk. Two ways to deal with the variations in future cash flows: determine several different scenarios or adjust the hurdle rate

Copyright © 2009 Pearson Education, Inc. publishing as Prentice Hall Internal Sources of Funds Funds are working capital, or current assets minus current liabilities. Sources of internal funds are:  Loans.  Investments through equity capital.  Intercompany receivables and payables.  Dividends.

Copyright © 2009 Pearson Education, Inc. publishing as Prentice Hall How the MNE Handles Its Funds (I): Internal Funds

Copyright © 2009 Pearson Education, Inc. publishing as Prentice Hall Global Cash Management Cash budgets and forecasts are essential in assessing a company’s cash needs. Dividends are a good source of intercompany transfers, but governments often restrict their free movement. Multilateral netting is the process of coordinating cash inflows and outflows among subsidiaries so that only net cash is transferred, reducing transaction costs. Netting requires sophisticated software and good banking relationships in different countries.

Copyright © 2009 Pearson Education, Inc. publishing as Prentice Hall How the MNE Handles Its Funds (II): Multilateral Cash Flows

Copyright © 2009 Pearson Education, Inc. publishing as Prentice Hall How the MNE Handles Its Funds (IV): Multilateral Netting

Copyright © 2009 Pearson Education, Inc. publishing as Prentice Hall Foreign-Exchange Risk Management Translation exposure arises because the dollar value of the exposed asset or liability changes as the exchange rate changes. Transaction exposure arises because the receivable or payable changes in value as the exchange rate changes. Economic, or operating, exposure arises from effects of exchange-rate changes on:  Future cash flows.  The sourcing of parts and components.  The location of investments.  The competitive position of the company in different markets.

Copyright © 2009 Pearson Education, Inc. publishing as Prentice Hall Exposure-Management Strategy To protect assets from exchange-rate risk, management needs to:  Define and measure exposure.  Establish a reporting system.  Adopt an overall policy on exposure management.  Formulate hedging strategies.

Copyright © 2009 Pearson Education, Inc. publishing as Prentice Hall Formulating Hedging Strategies Hedging strategies can be operational or financial. Operational strategies include:  Using local debt to balance local assets.  Taking advantage of leads and lags for intercompany payments. Forward contracts can establish a fixed exchange rate for future transactions. Currency options can ensure access to foreign currency at a fixed exchange rate for a specific period of time.

Copyright © 2009 Pearson Education, Inc. publishing as Prentice Hall Taxation of Foreign Source Income Tax planning influences profitability and cash flow. Taxation has a strong impact on several choices:  Location of operations  Choice of operating form, such as export or import, licensing agreement, overseas investment  Legal form of the new enterprise, such as branch or subsidiary  Possible facilities in tax-haven countries to raise capital and manage cash  Method of financing, such as internal or external sourcing and debt or equity  Capital budgeting decisions  Method of setting transfer prices

Copyright © 2009 Pearson Education, Inc. publishing as Prentice Hall International Tax Practices Problems with different countries’ tax practices arise from:  Lack of familiarity with laws.  Loose enforcement. With a value-added tax, each company pays a percentage of the value added to a product at each stage of the business process. Corporate tax rates vary from country to country.

Copyright © 2009 Pearson Education, Inc. publishing as Prentice Hall Approaches to Corporate Taxation In the separate entity approach, governments tax each taxable entity when it earns income. An integrated system tries to avoid double taxation of corporate income through split tax rates or tax credits.

Copyright © 2009 Pearson Education, Inc. publishing as Prentice Hall Taxing Branches And Subsidiaries Foreign branch income (or loss) is directly included in the parent’s taxable income. Tax deferral means that income from a subsidiary is not taxed until it is remitted to the parent company as a dividend. In a CFC, U.S. shareholders hold more than 50 percent of the voting stock. Active income is derived from the direct conduct of a trade or business. Passive income (also called Subpart F income) usually is derived from operations in a tax-haven country.

Copyright © 2009 Pearson Education, Inc. publishing as Prentice Hall The Tax-Haven Subsidiary as Holding Company

Copyright © 2009 Pearson Education, Inc. publishing as Prentice Hall The Tax Status of U.S.-Owned Foreign Subsidiaries

Copyright © 2009 Pearson Education, Inc. publishing as Prentice Hall Transfer Prices A transfer price is a price on goods and services one member of a corporate family sells to another. The OECD has set transfer pricing guidelines to eliminate the manipulation of prices and, therefore, taxes for MNEs.

Copyright © 2009 Pearson Education, Inc. publishing as Prentice Hall Double Taxation and Tax Credit The IRS allows a tax credit for corporate income tax U.S. companies pay to another country. A tax credit is a dollar-for-dollar reduction of tax liability and must coincide with the recognition of income. The purpose of tax treaties is to prevent double taxation or to provide remedies when it occurs.