1. Working Capital Management for the Multinational Corporation
International Financial Management
Dr. A. DeMaskey

2. Learning Objectives
How does multinational working capital management differ from domestic working capital management?
What are the objectives of international cash management?
What techniques are used by MNCs for making cross-border payments?
What key factors are associated with a firm’s funding strategy?
What short-term financing options are available?

3. Multinational Working Capital Management
Funds Availability
Additional Risks
Movement of Capital
Decisions
Taxes

4. International Cash Management
A set of activities, which consists of:
Cash management - the levels of cash balances held throughout the MNC -
Cash settlements and processing - the facilitation of its movement across borders

5. Cash Management
Cash levels are determined independently of working capital management decisions
Cash balances, including marketable securities, are held partly for day-to-day transactions and to protect against unanticipated variations from budgeted cash flows
These two motives are called the transaction motive and the precautionary motive.

6. International Cash Management
Goal: Minimize cash balances without reducing operations or increasing risk.
Steps:
Cash Planning - anticipating cash flows over future days, weeks, or months.
Cash Collection – getting cash into the firm as soon as possible.
Cash Mobilization – moving cash within the firm to the location where needed.
Cash Disbursements – planning procedures for distributing cash.
Covering Cash Shortages – managing anticipated cash shortages by borrowing locally.
Investing Surplus Cash – managing anticipated cash surpluses by investing locally or controlling them centrally.

7. Cash Positioning Decision
Currency of location
Type of liquid asset held
Maturities, yields, and liquidity characteristics

8. Objectives of an Effective Cash Management System
Minimizing overall cash requirements
Minimizing currency exposure risk
Minimizing political risk
Minimizing transactions costs
Taking full advantage of economies of scale

9. Complexities of the International Cash Positioning Decision
Conflicting nature of cash management objectives
Government restrictions
Multiple taxation systems
Multiple currencies

10. International Cash Settlements and Processing
Four techniques for simplifying and lowering the cost of settling cash flows between related and unrelated firms
Wire transfers
Cash pooling
Payment netting
Electronic fund transfers

11. Wire Transfers
Variety of methods but two most popular for cash settlements are CHIPS and SWIFT
CHIPS is the Clearing House Interbank Payment System owned and operated by its member banks
SWIFT is the Society for Worldwide Interbank Financial Telecommunications which also facilitates the wire transfer settlement process
Whereas CHIPS actually clears transactions, SWIFT is purely a communications system

12. Cash Pooling and Centralized Depositories
Key: Centralizing the cash positioning function to gain operational benefits.
Subsidiaries hold minimum cash for their own transactions and no cash for precautionary purposes
All excess funds are remitted to a central cash depository
Centralized depositories provide the following advantages:
Information advantage is attained by central depository on currency movements and interest rate risk
Precautionary balance advantages as MNC can reduce pool without any loss in level of protection
Interest rate advantages as funds can be borrowed at a lower cost and invested at a more advantageous rate.
Location can provide tax benefits, access to international communications, clearly defined legal procedures.

13. Multilateral Netting
Netting involves offsetting receivables against payables so that only the net amounts are transferred among affiliates.
Types
Bilateral netting
Multilateral netting
Payments netting is useful primarily when a large number of separate foreign exchange transactions occur between subsidiaries.

14. Payments Netting
Example: A Belgian affiliate owes an Italian affiliate $5,000,000, while the Italian affiliate simultaneously owes the Belgian affiliate $3,000,000.
Bilateral settlement calls for $2,000,000 payment from Belgium to Italy and cancellation of the remainder via offset.
Multilateral netting is an extension of bilateral netting.
Assume that payments are due between Apex’s European operations each month.
Without netting Apex de France would make three separate transactions each way.

15. Financing Working Capital
Financing working capital requirements of a MNC’s foreign affiliates poses a complex decision problem.
Financing options for a subsidiary include:
Intercompany loans from the parent or a sister affiliate.
Local currency financing.

16. Key Factors Underlying the Funding Strategy
Interest Rate
Without forward contracts
With forward contracts
Exchange Risk
Degree of Risk Aversion
Taxes
Political Risk

17. Financing Objectives Minimize covered after-tax interest costs
Minimize expects costs
Trade-off between expected cost and reducing the degree of cash flow exposure

18. Intercompany Loans
The cost of an intercompany loan is determined by the following factors:
Opportunity cost of funds
Interest rate
Tax rates and regulations
Currency of denomination
Expected exchange rate change

19. Local Currency Financing
Bank Loans
Term Loans
Line of Credit
Overdraft
Revolving Credit Agreement
Discounting
Commercial Paper

20. Effective Interest Rate on Bank Loans
Simple interest loan
Discount loan
Loan with compensating balance requirement

21. Effective Annual Percentage Cost Illustration
The Olivera Corporation, a manufacturer of olive oil products, needs to acquire €1 million in funds today to expand a pimiento-stuffing facility. Banca di Roma has offered them a choice of an 11% loan payable at maturity or a 10% loan on a discount basis. Which loan should Olivera choose?

22. Calculating the Dollar Costs of Alternative Financing Options
In deciding on a particular financing option, a firm needs to estimate and then compare the effective after-tax dollar costs of local currency financing and dollar financing.
In reality, the value of the currency borrowed will most likely change with respect to the borrower’s local currency over time.
Breakeven analysis can be used to determine the least expensive financing source for each future exchange rate.

23. Effective Financing Rate: No Taxes
Suppose that Ford has an affiliate in Mexico, which can borrow pesos at 80% or dollars at 12% for one year.
If the peso is expected to devalue from MP$ 7.50/$ at the beginning of the year to MP$ 10.23/$ at the end of the year, what is the expected before-tax dollar cost of the peso loan?
What is the cost of the dollar loan to Ford?
What is the breakeven rate of currency change at which the dollar cost of borrowing pesos is just equal to the cost of dollar financing?

24. Effective Financing Rate: No Taxes
Dollar cost of local currency (LC) loan
rH (LC) = rL (1 + c) + c
Cost of dollar loan (HC)
rH (HC) = rH
Breakeven rate of currency change
rL (1 + c) + c = rH

25. Effective Financing Rate: With Taxes
Suppose the Mexican corporate tax rate is 53%.
What is the expected after-tax dollar cost of borrowing pesos?
What is the expected after-tax cost of the dollar loan?
What is the breakeven rate of currency change at which the after-tax dollar cost of local currency financing is just equal to the after-tax cost of dollar financing?

26. Effective Financing Rate: With Taxes
After-tax dollar cost of borrowing local currency
rH (LC) = rL (1 - Ta)(1 + c) + c
After-tax cost of dollar loan
rH (HC) = rH (1 - Ta) + cTa
Breakeven rate of currency change
rL(1 - Ta)(1 + c) + c = rH(1 - Ta) + cTa