Question 1) Define direct foreign

investment (DFI). Why do countries

engage in international business?

Answer 1:
Multinational corporations frequently
capitalize on foreign business
opportunities by engaging in direct
foreign investment, which is investment
in real assets (such as land, buildings, or
even existing plants) in foreign countries.
They engage in joint ventures with
foreign firms, acquire foreign firms, and
form new foreign subsidiaries. Financial
managers must understand the potential
return and risk associated with DFI so that
they can make investment decisions that
maximize the MNC’s value.

Countries engage in international

business due to the following benefits:

1. Attract new sources of demand.

2. Enter markets where superior profits

are possible.

3. Exploit monopolistic advantages.

4. React to trade restrictions.

5. Diversify internationally.

6. Fully benefit from economies of scale.

7. Use foreign factors of production.

8. Use foreign raw materials.

9. Use foreign technology.

10. React to exchange rate movements.

The potential benefits from (DFI) vary

with the country. Countries in Western
Europe have well-established markets
where the demand for most products and
services is large. Thus, these countries
may appeal to MNCs that want to
penetrate markets because they have
better products than those already being
offered. Countries in Eastern Europe,
Asia, and Latin America tend to have
relatively low costs of land and labor.

Question 2: How could the value of

a MNC be affected? Show the MNC
valuation and explain.
Answer: The value of an MNC is relevant
to its shareholders and its debt holders.
When managers make decisions that
maximize the firm’s value, they also
maximize shareholder wealth (assuming
that the decisions are not intended to
maximize the wealth of debt holders at
the expense of shareholders). Given that
international financial management
should be conducted with the goal of
increasing the MNC’s value, it is useful to
review some basics of valuation. There
are numerous methods of valuing an
MNC, some of which lead to the same
valuation. The method described in this
section reflects the key factors affecting
an MNC’s value in a general sense.

Domestic Model:

Here. CFt Denoted expected cash flows to

be received at the end of period t; n is the
number of future periods in which cash
flows are received; and k represents not
only the weighted average Cost of capital
but also the required rate off return by
investors and creditors who provide funds
to the MNC

Multinational Model:
Here, CFt represents the amount of cash
flow denominated in a particular foreign
currency ‘j ‘at the end of period ‘t ‘, and

Sj,t denoted the exchange rate at which

the foreign currency (measured in dollars
per unit of the foreign currency) can be
converted to dollars at the end of period t

Question 3: Point out the agency

problems of MNC.

Answer 3: Managers of an MNC may

make decisions that conflict with the
firm’s goal of maximizing shareholder
wealth. For example, a decision to
establish a subsidiary in one location
versus another may be based on the
location’s appeal to a manager rather
than on its potential benefits to

shareholders. A decision to expand a

subsidiary may be motivated by a
manager’s desire to receive more
compensation rather than to enhance the

value of the MNC. This conflict of goals

between a firm’s managers and
shareholders is often referred to as the
agency problem.

The costs of ensuring that managers

maximize shareholder wealth (referred to
as agency costs) are normally larger for
MNCs than for purely domestic firms for
several reasons.
1. First, MNCs with subsidiaries
scattered around the world may
experience larger agency problems
because monitoring the managers of
distant subsidiaries in foreign
countries is more difficult.
2. Second, foreign subsidiary
managers who are raised in different
cultures may not follow uniform goals.
Some of them may believe that the
first priority should be to serve their
respective employees.
3. Third, the sheer size of the larger
MNCs can also create significant
agency problems, because it
 complicates the monitoring of
managers.

In some cases, agency problems can

occur because the goals of the entire

management of the MNC are not focused

on maximizing shareholder wealth.

Various forms of corporate control can

help prevent these agency problems and
thus induce managers to make decisions

that satisfy the MNC’s shareholders. If

these managers make poor decisions that
reduce the MNC’s value, then another
firm might acquire it at the lower price
and hence would probably remove the
weak managers. Moreover, institutional
investors (e.g., mutual and pension funds)
with large holdings of an MNC’s stock
have some influence over management
because they will complain to the board
of directors if managers are making poor
decisions.