International Financial International Financial EnvironmentEnvironment

Part IThe International Financial Environment

Multinational Corporation (MNC)

Foreign Exchange Markets

Product Markets Subsidiaries InternationalFinancialMarkets

DividendRemittance& FinancingExporting

& ImportingInvesting

& Financing

Goal of the MNCGoal of the MNCThe 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 MNCGoal of the MNCVarious 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 Theories of International BusinessBusiness 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 Theories of International BusinessBusinessProduct Cycle Theory

Firm creates product to accommodate local demand.

1Firm 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.

4bor

International International Business Business MethodsMethods

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 International Business MethodsBusiness 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 OpportunitiesInternational OpportunitiesCost-benefit Evaluation for

Purely Domestic Firms versus MNCs

Marginal Return on

Projects

Marginal Cost of Capital

Purely Domestic Firm

Purely Domestic Firm

MNC

MNC

Appropriate Size for Purely Domestic Firm

Appropriate Size for MNC

X YAsset Level of Firm

International OpportunitiesInternational OpportunitiesOpportunities 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 International OpportunitiesOpportunitiesOpportunities in Asia

◦ Significant growth expected for China

◦ Asian economic crisis in 1997-1998

Exposure to International Exposure to International RiskRiskExposure to Exchange Rate

Movements◦ exchange rate fluctuations affect cash

flows and foreign demandExposure to Foreign Economies

◦ economic conditions affect demandExposure to Political Risk

◦ political actions affect cash flows

Overview of an MNC’s Cash Overview of an MNC’s Cash FlowsFlows

Profile A: MNCs focused on International Trade

U.S. Businesses

Foreign Importers

U.S. Customers

Foreign Exporters

U.S.-based MNC

$ for products

$ for supplies

$ for exports

$ for imports

Overview of an MNC’s Cash Overview of an MNC’s Cash FlowsFlowsProfile B: MNCs focused on International Trade and

International Arrangements

U.S. Businesses

Foreign Importers

U.S. Customers

Foreign Exporters

Foreign Firms

U.S.-based MNC

$ for products

$ for supplies

$ for exports

$ for imports

$ for service

cost of service

Overview of an MNC’s Cash Overview of an MNC’s Cash FlowsFlows

Profile C: MNCs focused on International Trade, International Arrangements, and Direct Foreign Investment

U.S. Businesses

Foreign Importers

U.S. Customers

Foreign Exporters

Foreign Firms

Foreign 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 MNCValuation Model for an MNCValuing International Cash Flows

Value =

E CF E ER, ,

=

j t j tj

m

tt

n

k

1

1 1

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 MNCValuation Model for an MNC

Impact of New International Opportunities on an MNC’s Value

Value =

E CF E ER, ,

=

j t j tj

m

tt

n

k

1

1 1

More Exposure to Exchange Rate Risk

New International Opportunities

More Exposure to Political Risk

More Exposure to Foreign Economies

Multinational Corporations 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 suppliers3. Lower labor costs, maybe. 4. Better access to capital.  5. Greater operational efficiencies

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Top 10 MNCs by Revenues Top 10 MNCs by Revenues 20112011

1 Wallmart United States

2 ExxonMobile Corporation United States

3 Royal Dutch/Shell Group Netherlands/ UK

4 BP UK

5 Sinopec China

6 Toyota Motor Corporation Japan

7 Petro China China

8 TotalFina SA France

9 Chevron United States

10 Japan Post Holdings Japan