International Financial Management Associate Professor Ivar Bredesen ©2000 South-Western College Publishing

Multinational Financial Management: CHAPTER 1 Multinational Financial Management: An Overview 1

Chapter Objectives To identify the main goal of the MNC and conflicts with that goal; To describe the key theories that justify international business; and To explain the common methods used to conduct international business.

Goal of the MNC The commonly accepted goal of an MNC is to maximize shareholder wealth. For corporations with shareholders who differ from their managers, a conflict of goals can exist - the agency problem. Agency costs are normally larger for MNCs than for purely domestic firms, but can vary with the management style of the MNC.

Goal of the MNC Various forms of corporate control can reduce agency problems - stock compensation, threat of hostile takeover, monitoring by large shareholders. As MNC managers attempt to maximize their firm’s value, they may be confronted with various environmental, regulatory, or ethical constraints.

Corruption - the good guys

Corruption - the bad guys

Theories of International Business Why are firms motivated to expand their business internationally? Theory of Comparative Advantage Specialization by countries can increase production efficiency. Imperfect Markets Theory The markets for the various resources used in production are “imperfect.”

Theories of International Business Product Cycle Theory Firm creates product to accommodate local demand. 1 Firm exports product to accommodate foreign demand. 2 Firm establishes foreign subsidiary to establish presence in foreign country and possibly to reduce costs. 3 Firm differentiates product from competitors and/or expands product line in foreign country. 4a or Firm’s foreign business declines as its competitive advantages are eliminated. 4b

International Business Methods International Trade - a relatively conservative approach involving exporting and/or importing. Licensing - provision of technology in exchange for fees or some other benefits. Franchising - provision of a specialized sales or service strategy, support assistance, and possibly an initial investment in the franchise in exchange for periodic fees.

International Business Methods Joint Ventures - joint ownership and operation by two or more firms. Acquisitions of Existing Operations Establishing New Foreign Subsidiaries Any method of increasing international business that requires a direct investment in foreign operations normally is referred to as a direct foreign investment (DFI).

International Opportunities Cost-benefit Evaluation for Purely Domestic Firms versus MNCs Marginal Return on Projects Marginal Cost of Capital Purely Domestic Firm MNC Appropriate Size for Purely Domestic Firm Appropriate Size for MNC X Y Asset Level of Firm

Exposure to International Risk Exposure to Exchange Rate Movements exchange rate fluctuations affect cash flows and foreign demand Exposure to Foreign Economies economic conditions affect demand Exposure to Political Risk political actions affect cash flows

Overview of an MNC’s Cash Flows Profile A: MNCs focused on International Trade $ for products U.S. Customers U.S.-based MNC $ for supplies U.S. Businesses $ for exports Foreign Importers $ for imports Foreign Exporters

Overview of an MNC’s Cash Flows Profile B: MNCs focused on International Trade and International Arrangements $ for products U.S. Customers $ for supplies U.S. Businesses U.S.-based MNC $ for exports Foreign Importers $ for imports Foreign Exporters $ for service Foreign Firms cost of service

Overview of an MNC’s Cash Flows Profile C: MNCs focused on International Trade, International Arrangements, and Direct Foreign Investment U.S.-based MNC $ for products U.S. Customers $ for supplies U.S. Businesses $ for exports Foreign Importers $ for imports Foreign Exporters $ for service Foreign Firms cost of service funds remitted Foreign Subsidiaries funds invested

Valuation Model for an MNC Domestic Model where E (CF$,t ) = expected cash flows to be received at the end of period t n = the number of periods into the future in which cash flows are received k = the required rate of return by investors

Valuation Model for an MNC Valuing International Cash Flows where E (CFj,t ) = expected cash flows denominated in currency j to be received by the U.S. parent at the end of period t E (ERj,t ) = expected exchange rate at which currency j can be converted to dollars at the end of period t k = the weighted average cost of capital of the U.S. parent company

Valuation Model for an MNC Impact of New International Opportunities on an MNC’s Value More Exposure to Exchange Rate Risk New International Opportunities More Exposure to Political Risk More Exposure to Foreign Economies

How Chapters Relate to Valuation Exchange Rate Behavior (Chapters 6-8) Exchange Rate Risk Management (Chapters 9-12) Background on International Financial Markets (Chapters 2-5) Long-Term Investment and Financing Decisions (Chapters 13-18) Risk and Return of MNC Value and Stock Price of MNC Short-Term Investment and Financing Decisions (Chapters 19-21)

Chapter Review Goal of the MNC Conflicts against the MNC Goal Impact of MNC’s Management Style on Agency Costs Impact of Corporate Control on Agency Costs Constraints Interfering with the MNC’s Goal

Chapter Review Theories of International Business Theory of Comparative Advantage Imperfect Markets Theory Product Cycle Theory International Business Methods International Trade ¤ Licensing Franchising ¤ Joint Ventures Acquisitions of Existing Operations Establishing New Foreign Subsidiaries

Chapter Review Exposure to International Risk Exposure to Exchange Rate Movements Exposure to Foreign Economies Exposure to Political Risk

Chapter Review Overview of an MNC’s Cash Flows Valuation Model for an MNC Domestic Model Valuing International Cash Flows How Chapters Relate to Valuation