International Financial Environment

Part I The International Financial Environment Multinational Corporation (MNC)Foreign Exchange MarketsProduct MarketsSubsidiaries International Financial Markets Dividend Remittance & Financing Exporting & Importing Investing & Financing

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.

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 Firm’s foreign business declines as its competitive advantages are eliminated. 4b or

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 XY Asset Level of Firm

International Opportunities Opportunities in Europe ◦ Single European Act of 1987 ◦ Removal of the Berlin Wall in 1989 ◦ Single currency system in 1999 Opportunities in Latin America ◦ North American Free Trade Agreement (NAFTA) of 1993 ◦ General Agreement on Tariffs and Trade (GATT) accord

International Opportunities Opportunities in Asia ◦ Significant growth expected for China ◦ Asian economic crisis in

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 U.S. BusinessesForeign ImportersU.S. CustomersForeign Exporters U.S.- based MNC $ for products $ for supplies $ for exports $ for imports

Overview of an MNC’s Cash Flows Profile B: MNCs focused on International Trade and International Arrangements U.S. BusinessesForeign ImportersU.S. CustomersForeign ExportersForeign Firms U.S.- based MNC $ for products $ for supplies $ for exports $ for imports $ for service 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. BusinessesForeign ImportersU.S. CustomersForeign ExportersForeign FirmsForeign Subsidiaries U.S.- based MNC $ for products $ for supplies $ for exports $ for imports $ for service cost of service funds remitted funds invested

Valuation Model for an MNC Valuing International Cash Flows where E (CF j,t ) = expected cash flows denominated in currency j to be received by the U.S. parent at the end of period t E (ER j,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

Multinational Corporations A firm that has incorporated on one country and has production and sales operations in other countries. There are about 60,000 MNCs in the world. Many MNCs obtain raw materials from one nation, financial capital from another, produce goods with labor and capital equipment in a third country and sell their output in various other national markets. Advantages of the global economy for MNCs: 1. Spreading fixed costs like R&D over global sales. 2. Global purchasing power over suppliers 3. Lower labor costs, maybe. 4. Better access to capital. 5. Greater operational efficiencies 18

19 Top 10 MNCs by Revenues WallmartUnited States 2ExxonMobile CorporationUnited States 3Royal Dutch/Shell GroupNetherlands/ UK 4BPUK 5SinopecChina 6Toyota Motor CorporationJapan 7Petro ChinaChina 8TotalFina SAFrance 9ChevronUnited States 10Japan Post HoldingsJapan