International Business Quiz

Chapter 20 - Financial Management in the International Business

Chapter 20Financial Management in the International Business

True / False Questions

1. (p. 676) Investment decisions, in international business, are decisions about how to finance a firm's activities. FALSE

Difficulty: Medium

2. (p. 676) In international business, money management decisions are decisions about how to manage the firm's financial resources most efficiently. TRUE

Difficulty: Easy

3. (p. 676) In an international business, investment, financing and money management decisions are complicated by the fact that countries have different currencies. TRUE

Difficulty: Easy

4. (p. 676) Good financial management can be an important source of competitive advantage. TRUE

Difficulty: Easy

5. (p. 677) Capital budgeting quantifies the benefits, costs and risks of an investment. TRUE

Difficulty: Medium

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6. (p. 677) Capital budgeting for a foreign project does not use the same theoretical framework that domestic capital budgeting uses. FALSE

Difficulty: Medium

7. (p. 677) If the net present value of the discounted cash flows is slightly less than zero, the firm should go ahead with the project. FALSE

Difficulty: Medium

8. (p. 678) The problem of blocked earnings is much more serious than it was previously. FALSE

Difficulty: Easy

9. (p. 678) When using capital budgeting techniques to evaluate a potential foreign project, cash flows to the project and cash flows to the parent must be considered as one. FALSE

Difficulty: Medium

10. (p. 678) Stockholders do not perceive blocked earnings as contributing to the value of the firm and creditors do not count them when calculating the parent's ability to service its debt. TRUE

Difficulty: Medium

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11. (p. 678-679) In recent decades, the risk of outright expropriations has become almost zero. TRUE

Difficulty: Easy

12. (p. 679) Political risk assessment is more art than science. TRUE

Difficulty: Easy

13. (p. 680) In practice, the biggest problem arising from economic mismanagement has been rising interest rates. FALSE

Difficulty: Medium

14. (p. 680) Empirical studies show that there is a long-run relationship between a country's relative inflation rates and changes in exchange rates. TRUE

Difficulty: Easy

15. (p. 680) Surveys of actual practice within multinationals suggest that the practice of revising future cash flows downward is more popular than that of revising the discount rate upward. FALSE

Difficulty: Hard

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16. (p. 681) The cost of capital is typically lower in the global capital market, by virtue of its size and liquidity, than in many domestic capital markets. TRUE

Difficulty: Easy

17. (p. 681) The amount of local currency required to meet interest payments and retire principal on local debt obligations is not affected when a country's currency depreciates. TRUE

Difficulty: Medium

18. (p. 681) In capital budgeting decisions, the discount rate should be revised upward if a foreign government offers foreign firms low-interest loans, lowering the cost of capital. FALSE

Difficulty: Medium

19. (p. 681) Different tax regimes determine the relative attractiveness of debt and equity in a country. TRUE

Difficulty: Medium

20. (p. 682) Efficient money management involves minimizing cash balances and reducing transaction costs. TRUE

Difficulty: Easy

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21. (p. 682) Money market accounts offer a higher rate of interest than longer-term financial instruments like certificates of deposit. FALSE

Difficulty: Medium

22. (p. 682) Every time a firm changes cash from one currency into another currency it must bear a transaction cost. TRUE

Difficulty: Easy

23. (p. 682) According to the United Nations, less than 10 percent of international trade involves transactions between the different national subsidiaries of transnational corporations. FALSE

Difficulty: Medium

24. (p. 683) In the United States, the average effective corporate income rate is 35 percent. FALSE

Difficulty: Medium

25. (p. 683) A tax treaty between two countries is an agreement specifying what items of income will be taxed by the authorities of the country where the income is earned. TRUE

Difficulty: Easy

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26. (p. 683) A deferral principle specifies that parent companies are not taxed on foreign source income until they actually receive a dividend. TRUE

Difficulty: Easy

27. (p. 684) U.S. regulations tax U.S. shareholders on the firm's overseas income when it is earned, regardless of when the parent company in the United States receives it. TRUE

Difficulty: Medium

28. (p. 684) The practice of unbundling refers solely to the use of royalty payments and fees to transfer liquid funds across borders. FALSE

Difficulty: Medium

29. (p. 684) Fronting loans is the most common method by which firms transfer funds from foreign subsidiaries to the parent company. FALSE

Difficulty: Medium

30. (p. 685) A fee is compensation for professional services or expertise the parent company or another subsidiary supplies to a foreign subsidiary. TRUE

Difficulty: Easy

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31. (p. 685) Dividends have certain tax advantages over royalties and fees, particularly when the corporate tax rate is higher in the host country than in the parent's home country. FALSE

Difficulty: Medium

32. (p. 685) The price at which goods and services are transferred between entities within the firm is referred to as the transfer price. TRUE

Difficulty: Easy

33. (p. 686) Transfer pricing is consistent with a policy of treating each subsidiary in the firm as a profit center. FALSE

Difficulty: Medium

34. (p. 686-687) In a fronting loan, the parent company lends cash directly to the foreign subsidiary and the subsidiary repays it later. FALSE

Difficulty: Easy

35. (p. 687) A fronting loan does not provide any tax advantage. FALSE

Difficulty: Easy

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36. (p. 687) Fronting loans can circumvent host-country restrictions on the remittance of funds from a foreign subsidiary to the parent company. TRUE

Difficulty: Easy

37. (p. 688) In general, firms prefer each foreign subsidiary to hold its own cash balances. FALSE

Difficulty: Medium

38. (p. 688) By holding cash at a centralized depository, the firm may be able to invest its cash reserves more efficiently. TRUE

Difficulty: Easy

39. (p. 689) Multilateral netting compounds the transaction costs that arise when many transactions occur between a firm and its subsidiaries. FALSE

Difficulty: Medium

40. (p. 689) Multilateral netting is an extension of bilateral netting. TRUE

Difficulty: Easy

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Multiple Choice Questions

41. (p. 676) In international business, decisions about what activities to finance are best known as A. Investment decisionsB. Financing decisionsC. Money management decisionsD. Economic decisions

Difficulty: Medium

42. (p. 676) Theses are decisions about how to manage the firm's financial resources most efficiently. A. Investment decisionsB. Financing decisionsC. Money management decisionsD. Economic decisions

Difficulty: Easy

43. (p. 676) In international business, financing decisions are A. Decisions about what activities to financeB. Decisions about how to finance a firms activitiesC. Decisions about how to manage the firm's financial resources most efficientlyD. Decisions about the operational activities of a firm

Difficulty: Easy

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44. (p. 676) Good financial management can help a firm in all of the following ways, except A. Reduce the costs of creating valueB. Add value by improving customer serviceC. Reduce the firm's cost of capitalD. Totally eliminate the firm's tax burden

Difficulty: Medium

45. (p. 677) _____ can best help financial manager in an international business to quantify the various benefits, costs and risks that are likely to flow from an investment in a given location. A. Operational techniquesB. Capital budgeting techniquesC. Socio-economic techniquesD. Production techniques

Difficulty: Hard

46. (p. 677) Capital budgeting A. In practice is a very simple and perfect processB. Techniques are not useful for quantifying the benefits, costs and risks of an investmentC. For a foreign project uses the same theoretical framework that domestic capital budgeting usesD. Techniques, for evaluating potential foreign projects, do not require the firm to recognize the specific risks arising from its foreign location

Difficulty: Hard

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47. (p. 677) Identify the incorrect statement regarding cash flows that a firm must estimate, to decide if it should go ahead with a project. A. In most cases, the cash flows will be negative at first, because the firm will be investing heavily in production facilitiesB. After some initial period the cash flows becomes positive as investment costs decline and revenues growC. Once the cash flows have been estimated, they must be discounted to determine their net present value using an appropriate discount rateD. If the net present value of the discounted cash flows is less than zero, the firm should go ahead with the project

Difficulty: Hard

48. (p. 678) All of the following are factors complicating the capital budgeting process for an international business except A. A distinction must be made between cash flows to the project and cash flows to the parent companyB. Cash flows to the project and to the parent company will be the same when a host-country government blocks the repatriation of cash flows from a foreign investmentC. Political and economic risks, including foreign exchange risk, can significantly change the value of a foreign investmentD. The connection between cash flows to the parent and the source of financing must be recognized

Difficulty: Hard

49. (p. 678) Restrictions on a project, because of which a firm may not be able to remit all its cash flows to the parent company, A. Do not affect the net present value of the project to the parent companyB. Do not affect the net present value of the project itselfC. Do not limit the cash flows of the parent company in any mannerD. Establishes the fact that a foreign project need not be analyzed from the perspective of the parent company

Difficulty: Hard

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50. (p. 678) Which of the following statements is not true about government restrictions that block earnings from a foreign project? A. The problem of blocked earnings is now much more serious than beforeB. Greater acceptance of free market economics has reduced the number of countries in which governments are likely to block earningsC. Firms have a number of options for circumventing host-government attempts to block the free flow of funds from an affiliateD. Stockholders do not perceive blocked earnings as contributing to the value of the firm

Difficulty: Hard

51. (p. 678) Identify the incorrect statement regarding political risk. A. It can be defined it as the likelihood that political forces will cause drastic changes in a country's business environment that hurt the profit and other goals of a businessB. It tends to be greater in countries where the underlying nature of the society makes the likelihood of social unrest highC. When political risk is high, there is a high probability that a change will occur in the country's political environment that will endanger foreign firms thereD. In most cases, political change may result in the expropriation of foreign firms' assets

Difficulty: Medium

52. (p. 679) Political risk assessment A. Is without valueB. Is more science than artC. Tries to predict a future that can only be guessedD. Usually makes correct future predictions

Difficulty: Medium

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53. (p. 680) In practice, the biggest problem arising from economic mismanagement has been A. Blocked earningsB. InflationC. Economic collapseD. The outright expropriations of foreign firms' assets

Difficulty: Easy

54. (p. 680) Historically, many governments have expanded their domestic money supply in misguided attempts to stimulate economic activity. The result has often been A. Price inflationB. Low interest ratesC. A strong local currencyD. Private sector growth

Difficulty: Easy

55. (p. 680) The relationship between a country's relative inflation rates and changes in exchange rates is, A. Much closer than what theory would predictB. Not reliable in the short runC. Totally reliable in the long runD. According to empirical studies, non existent in the long run

Difficulty: Medium

56. (p. 680) Adjusting discount rates to reflect a location's riskiness A. Is not widely practiced by firmsB. Treats all risk as a single problemC. Penalizes distant cash flows too heavilyD. Does not penalize early cash flows enough

Difficulty: Hard

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57. (p. 680) One method of analyzing a foreign investment opportunity is to treat all risk as a single problem by adjusting the discount rate applicable. For countries with significant political and economic risks, the A. Discount rates are revised upwardB. Discount rates are revised downwardC. Early cash flows are not adjustedD. Distant cash flows are heavily penalized

Difficulty: Medium

58. (p. 681) For firm's seeking external financing for a project, the cost of capital is typically lower in A. Global capital marketsB. Domestic capital marketsC. Small marketsD. Relatively illiquid markets

Difficulty: Easy

59. (p. 681) In capital budgeting decisions, the discount rate must be adjusted downward A. In countries where liquidity is limitedB. When the cost of capital used to finance a project is highC. In countries where governments offer foreign firms low-interest loansD. In countries where the perceived political and economic risks are greater

Difficulty: Medium

60. (p. 681) Identify the incorrect statement pertaining to financial structures. A. The financial structures of firms are remarkably similar across countriesB. It can be described as the mix of debt and equity used to finance a businessC. Different tax regimes determine the relative attractiveness of debt and equity in a countryD. An international business should adopt a financial structure for each foreign affiliate that minimizes its cost of capital

Difficulty: Medium

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61. (p. 681) This is defined as the mix of debt and equity used to finance a business. A. Portfolio analysisB. Investment ratioC. Balance sheetD. Financial structure

Difficulty: Easy

62. (p. 682) _____ decisions attempt to manage a firm's working capital most efficiently. A. InvestmentB. Money managementC. PortfolioD. Organization structure

Difficulty: Easy

63. (p. 682) The commission fee a firm pays to foreign exchange dealers for changing cash from one currency into another currency is known as A. Foreign exchange taxB. Transfer feeC. Transaction costD. Conversion tax

Difficulty: Easy

64. (p. 682) These are the charges that most banks take for moving cash from one location to another. A. Currency taxesB. Location feeC. Exchange chargesD. Transfer fee

Difficulty: Easy

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65. (p. 683) Which of the following observations is true? A. Japan has the lowest corporate income tax rateB. Ireland has a relatively high corporate income tax rateC. Japan has the highest tax rate on dividendsD. France has a relatively high tax rate on dividends

Difficulty: Hard

66. (p. 683) This occurs when both the host-country government and the parent company's home government tax the income of a foreign subsidiary. A. Double taxationB. Tax duplicationC. Tax discrepancyD. Indirect taxation

Difficulty: Easy

67. (p. 683) A _____ allows an entity to reduce the taxes paid to the home government by the amount of taxes paid to the foreign government. A. Tax treatyB. Tax creditC. Deferral principleD. Tax benefit

Difficulty: Easy

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68. (p. 683) A tax treaty A. Allows an entity to reduce the taxes paid to the home government by the amount of taxes paid to the foreign governmentB. Directs both the host-country government and the parent company's home government to tax the income of a foreign subsidiaryC. Between two countries is an agreement specifying what items of income will be taxed by the authorities of the country where the income is earnedD. Specifies that parent companies are not taxed on foreign source income until they actually receive a dividend

Difficulty: Medium

69. (p. 683) Which of the following specifies that parent companies are not taxed on foreign source income until they actually receive a dividend? A. Tax treatyB. Tax creditC. Deferral principleD. Tax benefit

Difficulty: Easy

70. (p. 684) A tax haven A. Allows an entity to reduce the taxes paid to the home government and those paid to foreign governmentsB. Directs both the host-country government and the parent company's home government not to tax the income of a foreign subsidiaryC. Specifies that parent companies are not taxed on foreign source income until they actually receive a dividendD. Is a country with an exceptionally low or even no, income tax

Difficulty: Easy

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71. (p. 684) By using a mix of techniques to transfer liquid funds from a foreign subsidiary to the parent company, _____ allow(s) an international business to recover funds from its foreign subsidiaries without piquing host-country sensitivities with large "dividend drains." A. UnbundlingB. Tax treatiesC. The deferral principleD. Tax havens

Difficulty: Medium

72. (p. 684-685) Which of the following represents the remuneration paid to the owners of technology, patents or trade names for the use of that technology or the right to manufacture and/or sell products under those patents or trade names? A. TrademarksB. RoyaltiesC. CopyrightsD. Patents

Difficulty: Medium

73. (p. 685) Identify the incorrect statement about royalties and fees. A. Royalties may be levied as a fixed monetary amount per unit of the product the subsidiary sells or as a percentage of a subsidiary's gross revenuesB. A fee is compensation for professional services or expertise the parent company or another subsidiary supplies to a foreign subsidiaryC. Royalties may be differentiated into "management royalties" for general expertise and advice and "technical assistance royalties" for guidance in technical mattersD. Royalties and fees are often tax-deductible locally, so arranging for payment in royalties and fees will reduce a foreign subsidiary's tax liability

Difficulty: Medium

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74. (p. 685) The price at which goods and services are transferred between entities within the firm is referred to as A. Transfer taxB. Service taxC. Service chargesD. Transfer price

Difficulty: Easy

75. (p. 685) All of the following are gains that can be derived by manipulating transfer prices, except A. A firm can reduce its tax liabilities by shifting earnings from a high-tax country to a low-tax oneB. A firm can move funds out of a country where a significant currency devaluation is expected, thereby reducing its exposure to foreign exchange riskC. Funds can be moved by a firm from a subsidiary to the parent company when financial transfers in the form of dividends are blocked by host-country government policiesD. If there are high transfer prices on goods or services being imported into the country, a firm can reduce the import duties it must pay when an ad valorem tariff is in force

Difficulty: Hard

76. (p. 686) This is a loan between a parent and its subsidiary channeled through a financial intermediary, usually a large international bank. A. International loanB. Fronting loanC. Transfer loanD. Unbundling loan

Difficulty: Easy

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77. (p. 686-687) Which of the following is not an advantage of a fronting loan? A. They help a multinational to make a direct intrafirm loan, where the parent company lends cash directly to the foreign subsidiary and the subsidiary repays it laterB. They can circumvent host-country restrictions on the remittance of funds from a foreign subsidiary to the parent companyC. They can be used by multinationals to lend funds to a subsidiary based in a country with a fairly high probability of political turmoil that might lead to restrictions on capital flowsD. They can also provide tax advantages to international businesses

Difficulty: Hard

78. (p. 688) In general, firms prefer to hold cash balances at a centralized depository for all of the following reasons except A. By pooling cash reserves centrally, the firm can deposit larger amountsB. It enables the firm to invest a larger amount of cash reserves in short-term, highly liquid financial instruments that earn a lower interest rateC. If the centralized depository is located in a major financial center, it has access to information about good short-term investment opportunities that the typical foreign subsidiary would lackD. The firm can reduce the total size of the cash pool it must hold in highly liquid accounts

Difficulty: Hard

79. (p. 689) A French subsidiary owes a Mexican subsidiary $6 million and the Mexican subsidiary simultaneously owes the French subsidiary $4 million. Through a mutual settlement a single payment of $2 million is made from the French subsidiary to the Mexican subsidiary, the remaining debt being canceled. This example best exemplifies A. Bilateral nettingB. A transfer loanC. UnbundlingD. A fronting loan

Difficulty: Hard

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80. (p. 689) This allows a multinational firm to reduce the transaction costs that arise when many transactions occur between its subsidiaries. A. UnbundlingB. Deferral principleC. Fronting loanD. Multilateral netting

Difficulty: Easy

Essay Questions

81. (p. 676) Identify the main sets of related decisions included within the scope of financial management in the international business.

Three sets of related decisions, included within the scope of financial management are: 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 firm's financial resources most efficiently.

Difficulty: Easy

82. (p. 676) What is the role of investment, financing and money management decisions in an international business?

In an international business, investment, financing and money management decisions are complicated by the fact that countries have different currencies, different tax regimes, different regulations concerning the flow of capital across their borders, different norms regarding the financing of business activities, different levels of economic and political risk and so on. Financial managers must consider all these factors when deciding which activities to finance, how best to finance those activities, how best to manage the firm's financial resources and how best to protect the firm from political and economic risks. Good financial management can be an important source of competitive advantage.

Difficulty: Medium

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83. (p. 677) What is capital budgeting?

Capital budgeting quantifies the benefits, costs and risks of an investment. This enables top managers to compare, in a reasonably objective fashion, different investment alternatives within and across countries so they can make informed choices about where the firm should invest its scarce financial resources. In capital budgeting a firm must first estimate the cash flows associated with the project over time. In most cases, the cash flows will be negative at first, because the firm will be investing heavily in production facilities. After some initial period, however, the cash flows will become positive as investment costs decline and revenues grow. Once the cash flows have been estimated, they must be discounted to determine their net present value using an appropriate discount rate.

Difficulty: Medium

84. (p. 678) What are the factors complicating the process of capital budgeting for an international business?

Capital budgeting is in practice a very complex and imperfect process. Following are the factors complicating the process for an international business: 1. A distinction must be made between cash flows to the project and cash flows to the parent company. 2. Political and economic risks, including foreign exchange risk, can significantly change the value of a foreign investment. 3. The connection between cash flows to the parent and the source of financing must be recognized.

Difficulty: Medium

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85. (p. 678) Should foreign project be analyzed from the perspective of the parent company?

A theoretical argument exists for analyzing any foreign project from the perspective of the parent company because cash flows to the project are not necessarily the same thing as cash flows to the parent company. The project may not be able to remit all its cash flows to the parent for a number of reasons. Cash flows may be blocked from repatriation by the host-country government, they may be taxed at an unfavorable rate or the host government may require a percentage of cash flows generated from the project be reinvested within the host nation. While these restrictions don't affect the net present value of the project itself, they do affect the net present value of the project to the parent company because they limit the cash flows that can be remitted to it from the project.

Difficulty: Hard

86. (p. 678-679) What are political risks? Why must a company evaluating foreign investment opportunities consider the political risks that stem from the foreign location?

Political risk can be defined as the likelihood that political forces will cause drastic changes in a country's business environment that hurt the profit and other goals of a business enterprise. When political risk is high, there is a high probability that a change will occur in the country's political environment that will endanger foreign firms there. In extreme cases, political change may result in the expropriation of foreign firms' assets. It may also result in economic collapse, which can render a firm's assets worthless. In less extreme cases, political changes may result in increased tax rates, the imposition of exchange controls that limit or block a subsidiary's ability to remit earnings to its parent company, the imposition of price controls and government interference in existing contracts.

Difficulty: Medium

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87. (p. 680) What is economic risk? How does it affect international businesses?

Economic risk can be defined as the likelihood that economic mismanagement will cause drastic changes in a country's business environment that hurt the profit and other goals of a business enterprise.The biggest problem arising from economic mismanagement has been inflation. Price inflation is reflected in a drop in the value of a country's currency on the foreign exchange market. This can be a serious problem for a foreign firm with assets in that country because the value of the cash flows it receives from those assets will fall as the country's currency depreciates on the foreign exchange market. The likelihood of this occurring decreases the attractiveness of foreign investment in that country.

Difficulty: Medium

88. (p. 680) In analyzing a foreign investment opportunity, how can the additional risk that stems from its location be handled?

The additional risk that stems from location can be handled in at least two ways. The first method is to treat all risk as a single problem by increasing the discount rate applicable to foreign projects in countries where political and economic risks are perceived as high. The higher the discount rate, the higher the projected net cash flows must be for an investment to have a positive net present value. The second method revises future cash flows downward. This method, rather than using a higher discount rate to evaluate risky projects, which penalizes early cash flows too heavily, revises future cash flows from the project downward to reflect the possibility of adverse political or economic changes sometime in the future.

Difficulty: Hard

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89. (p. 681) What are the factors a firm considers while externally financing for a project?

If the firm is going to seek external financing for a project, it will want to borrow funds from the lowest cost source of capital available. Firms increasingly are turning to the global capital market to finance their investments. The cost of capital is typically lower in the global capital market, by virtue of its size and liquidity, than in many domestic capital markets, particularly those that are small and relatively illiquid.However, despite the trends towards deregulation of financial services, in some cases host-country government restrictions may rule out this option. In addition to the impact of host-government policies on the cost of capital and financing decisions, the firm may wish to consider local debt financing for investments in countries where the local currency is expected to depreciate on the foreign exchange market.

Difficulty: Hard

90. (p. 681) Define financial structure. Is it the same across various countries, if not why?

Financial structure can be defined as the mix of debt and equity used to finance a business. There is a difference in the financial structures of firms based in different countries. It is not clear why the financial structure of firms varies so much across countries. One possible explanation is that different tax regimes determine the relative attractiveness of debt and equity in a country. However, according to empirical research, country differences in financial structure do not seem related in any systematic way to country differences in tax structure. Another possibility is that these country differences may reflect cultural norms. This explanation may be valid, although the mechanism by which culture influences capital structure has not yet been explained.

Difficulty: Medium

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91. (p. 682) Should international businesses conform to local capital structure norms?

One advantage claimed for conforming to host-country debt norms is that management can more easily evaluate its return on equity relative to local competitors in the same industry. However, this seems a weak rationale for what is an important decision. Another point often made is that conforming to higher host-country debt norms can improve the image of foreign affiliates that have been operating with too little debt and thus appear insensitive to local monetary policy. Just how important this point is, however, has not been established. The best recommendation is that an international business should adopt a financial structure for each foreign affiliate that minimizes its cost of capital, irrespective of whether that structure is consistent with local practice.

Difficulty: Easy

92. (p. 682) What are cash balances? Why are they important for a firm?

For any given period, a firm must hold certain cash balances. This is necessary for serving any accounts and notes payable during that period and as a contingency against unexpected demands on cash. A firm typically invests its cash reserves in money market accounts so it can earn interest on them. However, it must be able to withdraw its money from those accounts freely. Such accounts typically offer a relatively low rate of interest. In contrast, the firm could earn a higher rate of interest if it could invest its cash resources in longer-term financial instruments. The problem with longer-term instruments, however is that the firm cannot withdraw its money before the instruments mature without suffering a financial penalty.Thus, the firm faces a dilemma. If it invests its cash balances in money market accounts, it will have unlimited liquidity but earn a relatively low rate of interest. If it invests its cash in longer-term financial instruments, it will earn a higher rate of interest, but liquidity will be limited. In an ideal world, the firm would have minimal liquid cash balances.

Difficulty: Medium

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93. (p. 682) What are transaction costs? How can they be reduced?

Transaction costs are the cost of exchange. Every time a firm changes cash from one currency into another currency it must bear a transaction cost—the commission fee it pays to foreign exchange dealers for performing the transaction. Most banks also charge a transfer fee for moving cash from one location to another; this is another transaction cost. The commission and transfer fees arising from intrafirm transactions can be substantial.Multilateral netting can reduce the number of transactions between the firm's subsidiaries, thereby reducing the total transactions costs arising from foreign exchange dealings and transfer fees.

Difficulty: Medium

94. (p. 683) Differentiate between a tax credit, a tax treaty and a deferral principle. What is their importance in international business?

A tax credit allows an entity to reduce the taxes paid to the home government by the amount of taxes paid to the foreign government. A tax treaty between two countries is an agreement specifying what items of income will be taxed by the authorities of the country where the income is earned. A deferral principle specifies that parent companies are not taxed on foreign source income until they actually receive a dividend.For the international business with activities in many countries, the various tax regimes and tax treaties have important implications for how the firm should structure its internal payments system among the foreign subsidiaries and the parent company. The firm can use transfer prices and fronting loans to minimize its global tax liability. In addition, the form in which income is remitted from a foreign subsidiary to the parent company can be structured to minimize the firm's global tax liability.

Difficulty: Medium

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95. (p. 684) What are tax havens? What is their importance in international business?

A tax haven is a country with an exceptionally low or even no, income tax. Some firms use tax havens such as the Bahamas and Bermuda to minimize their tax liability. International businesses avoid or defer income taxes by establishing a wholly owned, nonoperating subsidiary in the tax haven. The tax haven subsidiary owns the common stock of the operating foreign subsidiaries. This allows all transfers of funds from foreign operating subsidiaries to the parent company to be funneled through the tax haven subsidiary. The tax levied on foreign source income by a firm's home government, which might normally be paid when a foreign subsidiary declares a dividend, can be deferred under the deferral principle until the tax haven subsidiary pays the dividend to the parent. This dividend payment can be postponed indefinitely if foreign operations continue to grow and require new internal financing from the tax haven affiliate.

Difficulty: Medium

96. (p. 684) How are dividend remittances used by firms to transfer funds from foreign subsidiaries to the parent company?

Payment of dividends is probably the most common method by which firms transfer funds from foreign subsidiaries to the parent company. The dividend policy typically varies with each subsidiary depending on such factors as tax regulations, foreign exchange risk, the age of the subsidiary and the extent of local equity participation. With regard to foreign exchange risk, firms sometimes require foreign subsidiaries based in "high-risk" countries to speed up the transfer of funds to the parent through accelerated dividend payments. This moves corporate funds out of a country whose currency is expected to depreciate significantly. The age of a foreign subsidiary influences dividend policy in that older subsidiaries tend to remit a higher proportion of their earnings in dividends to the parent, presumably because a subsidiary has fewer capital investment needs as it matures.

Difficulty: Hard

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97. (p. 684-685) What are royalties and fees?

Royalties represent the remuneration paid to the owners of technology, patents or trade names for the use of that technology or the right to manufacture and/or sell products under those patents or trade names. It is common for a parent company to charge its foreign subsidiaries royalties for the technology, patents or trade names it has transferred to them. Royalties may be levied as a fixed monetary amount per unit of the product the subsidiary sells or as a percentage of a subsidiary's gross revenues.A fee is compensation for professional services or expertise the parent company or another subsidiary supplies to a foreign subsidiary. Fees are sometimes differentiated into "management fees" for general expertise and advice and "technical assistance fees" for guidance in technical matters. Fees are usually levied as fixed charges for the particular services provided.

Difficulty: Easy

98. (p. 685) Define transfer price. Enumerate the benefits of manipulating transfer prices.

The price at which goods and services are transferred between entities within the firm is referred to as the transfer price.At least four gains can be derived by manipulating transfer prices:1. The firm can reduce its tax liabilities by using transfer prices to shift earnings from a high-tax country to a low-tax one.2. The firm can use transfer prices to move funds out of a country where a significant currency devaluation is expected, thereby reducing its exposure to foreign exchange risk.3. The firm can use transfer prices to move funds from a subsidiary to the parent company when financial transfers in the form of dividends are restricted or blocked by host-country government policies.4. The firm can use transfer prices to reduce the import duties it must pay when an ad valorem tariff is in force. In this case, low transfer prices on goods or services being imported into the country are required. Since this lowers the value of the goods or services, it lowers the tariff.

Difficulty: Hard

20-29


99. (p. 687) What are fronting loans? Why are they used by multinationals?

A fronting loan is a loan between a parent and its subsidiary channeled through a financial intermediary, usually a large international bank.Firms use fronting loans for two reasons. First, fronting loans can circumvent host-country restrictions on the remittance of funds from a foreign subsidiary to the parent company.A fronting loan can also provide tax advantages.

Difficulty: Easy

100. (p. 688) Why do firms prefer to hold cash balances at a centralized depository?

First, by pooling cash reserves centrally, the firm can deposit larger amounts. Cash balances are typically deposited in liquid accounts, such as overnight money market accounts. Because interest rates on such deposits normally increase with the size of the deposit, by pooling cash centrally, the firm should be able to earn a higher interest rate than it would if each subsidiary managed its own cash balances.Second, if the centralized depository is located in a major financial center, it should have access to information about good short-term investment opportunities that the typical foreign subsidiary would lack.Third, by pooling its cash reserves, the firm can reduce the total size of the cash pool it must hold in highly liquid accounts, which enables the firm to invest a larger amount of cash reserves in longer-term, less liquid financial instruments that earn a higher interest rate.

Difficulty: Hard

20-30

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International Business Quiz