INTERNATIONAL

FINANCIAL
MANAGEMENT

1
Pre-Requisite: Financial Management & Principle of
Management,
Financial & Managerial Accounting,
Basic Economic, Corporate Finance
and Financial Risk Management
Recommended Books International Financial
Management
by Jeff Medora
by Cheol Eun & Bruce G.
Resnick
Co-requisites = Ability to access online sources
2
of the academic research material
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 Introduction
Management: The process of attaining organizational goals
by effectively and efficiently planning, organizing, leading
and controlling the organization's human, physical,
financial and information resources.
The process of using organizational resources to achieve the
organization’s goals by...
Planning, Organizing, Leading, and Controlling

Financial Management. The acquisition, financing and

management of assets with some over all goal in mind.
Decision function of financial management can be broken
down into three major areas [Investment, Financing and
Assets Management]
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 Over view of IFM

Foundation of the IFM is Globalization and Multinational

Corporation
• To identify the main goal of the multinational corporation
(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.

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Need to study IFM

Production
Consumption (MNCs persistent
efforts to source in-
(import of put and locate
various items production
from other anywhere in the
World where costs
counrties) are lower and profits
are higher)

Investment
(Direct and through
Acquisition)

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 Goal for IFM

Maximization
of Market
Share

Overall
Welfare of
Stakeholder
Shareholders,
Employees,
Suppliers, Shareholder
Customer etc Wealth
Maximization
Making all decision
with a view to make
them better off
financially than they
were before.

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 Goal of IFM
Goal Objectives Advantages Disadvantages
1. Easy to calculate Emphasizes on short
Profit Large profits.
1.
term
Maximization amount of 2. Easy to determine 2. Ignores risk and
profits line between uncertainty
financial decision 3. Ignores the timing of
and profits return
4. Requires immediate
resources

Shareholders Highest 1. Emphasizes the 1. No clear relationship

long term between financial
wealth market 2. Recognize risk or decisions and stock
maximization value of uncertainty price
2. Can lead to
common 3. Recognizes te
management anxiety
timing of returns
stock and frustration
4. Considers
shareholders return
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Conflicts Against the MNC Goal

• 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.
– The sheer size of the MNC.
– The scattering of distant subsidiaries.
– The culture of foreign managers.
– Subsidiary value versus overall MNC value.
 Impact of Corporate Control
• Various forms of corporate control can
reduce agency costs.
– Stock compensation for board members and
executives.
– The threat of a hostile takeover.
– Monitoring and intervention by large
shareholders.
 Constraints
Interfering with the MNC’s Goal
• As MNC managers attempt to maximize
their firm’s value, they may be confronted
with various constraints.
– Environmental constraints.
– Regulatory constraints.
– 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.”
 Product Cycle Theory
– As a firm matures, it may recognize additional
opportunities outside its home country
 International
Business Methods
There are several methods by which firms can
conduct international business.
• International trade is a relatively
conservative approach involving
exporting and/or importing.
– The internet facilitates international trade
by enabling firms to advertise and manage
orders through their websites.
 International
Business Methods
• Licensing allows a firm to provide its
technology in exchange for fees or some
other benefits.
• Franchising obligates a firm to provide a
specialized sales or service strategy,
support assistance, and possibly an initial
investment in the franchise in exchange
for periodic fees.
 International
Business Methods
• Firms may also penetrate foreign markets
by engaging in a joint venture (joint
ownership and operation) with firms that
reside in those markets.
• Acquisitions of existing operations in
foreign countries allow firms to quickly
gain control over foreign operations as
well as a share of the foreign market.
 International
Business Methods
• Firms can also penetrate foreign markets by
establishing new foreign subsidiaries.
• In general, any method of conducting
business that requires a direct investment in
foreign operations is referred to as a direct
foreign investment (DFI).
• The optimal international business method
may depend on the characteristics of the
MNC.
Exposure to International Risk

International business usually increases an

MNC’s exposure to:
exchange rate movements
– Exchange rate fluctuations affect cash
flows and foreign demand.
foreign economies
– Economic conditions affect demand.
political risk
– Political actions affect cash flows.
 Managing for Value
• Like domestic projects, foreign projects
involve an investment decision and a
financing decision.
• When managers make multinational
finance decisions that maximize the
overall present value of future cash flows,
they maximize the firm’s value, and hence
shareholder wealth.
 Valuation Model for an MNC

• Domestic Model
n
E CF$, t 
Value = 
t =1 1  k 
t

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
m 
n 
E CFj , t  E ER j , t 
 j 1 
Value =   
t =1  1  k  t

 
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
• An MNC’s financial decisions include how
much business to conduct in each country
and how much financing to obtain in each
currency.
• Its financial decisions determine its
exposure to the international environment.
 Valuation Model for an MNC
Impact of New International Opportunities
on an MNC’s Value

Exposure to
Foreign Economies Exchange Rate Risk

m 
n 
E CFj , t  E ER j , t 
 j 1 
Value =   
t =1  1  k  t

 

Political Risk
M/s Star Plc an UK Company are planning to launch a
food processing unit which will generate a cash flow of
GBP 100,000/- at end of each year for five years, the
expected rate of return of the company is 10%. The
company has an opportunity the install the same plant at
New Zeeland from where the cash flow will be generated
as NZD 110,000 at the end of first year which will
increase on the coming four years at 3%. The exchange
rate at the end of first year, between GBP and NZD, will
be NZD 1.5695 and NZD is expecting to depreciate @
3% of next every year. The expected rate of return of
company at New Zeeland will also increase as 15% due
to taxation system of New Zeeland.
Whether the Company should launch the plant
domestically or otherwise? 23