International

Financial
Management
Semester 1, 2017
Biplob Chowdhury
E: biplob.chowdhury@utas.edu.au

University of Tasmania
Tasmanian School of Business and Economics
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 CRICOS Provider Code: 00586B

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permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom
 Administrative details:

Lecturer and unit coordinator : Biplob

Chowdhury, Room 140 (Level 1), Centenary
Building

email: Biplob.Chowdhury@utas.edu.au
phone: 0424999817

Consultation hours: Thursday 2pm-3pm/ by

appointment and/or after class

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 Prescribed Text:
• Madura, J. (2015). International Financial Management (12ed). Cangage
Learning.
Reference Texts:
• Eun, C. and Resnick, B. (2012or Newer). International
Financial Management (6ed). McGraw-Hill.
• Shapiro, A. (2013or Newer). Multinational Financial Management
(10ed). Wiley.
Assessments:

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 Weekly Workshop Solution Submission
• Weekly workshop problem set contains 4 to 10 questions.
• All students must submit answers to the weekly workshop questions (from week 2 to week 12).
• Need to submit individually.
• Must submit in MyLO dropbox.

Multiple Choice Quiz

• Online quiz will consist of 20 multiple choice questions.
• Task length 30 minutes

Major Assignment
• TBA
• This is a research report. Students will be organised into groups of no more than three student per group.
The Research topic and further instructions will be posted on MyLO by the end of week 2

Final Examination

Section Question format Number of questions Worth

A Multiple choice 20 questions 40 marks
B Multiple part 8 questions (Answer 6 140 marks
questions)
180 marks

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 It is expected that you attend all tutorials and
lectures if you are a face-to-face students and
listen all lectures and tutorials if you are a
distance students.
It is expected that you bring your book to all
tutorials and lectures.

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 International Financial Management
12th Edition
by Jeff Madura

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 1Multinational Financial Management: An Overview
Chapter Objectives

 Identify the management goal and organizational

structure of the Multinational Corporation (MNC).
 Describe the key theories that justify
international business
 Explain the common methods used to
conduct international business
 Provide a model for valuing the MNC
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 Managing the MNC

1. Managers are expected to make decisions

that will maximize the stock price.
2. Focus of this text: MNCs whose parents fully
own foreign subsidiaries (U.S. parent is sole
owner of subsidiary.)
3. Finance decisions are influenced by other
business discipline functions:
 Marketing
 Management
 Accounting and information systems
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 Agency Problems

The conflict of goals between managers and

shareholders

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 Agency Costs

1. Definition: Cost of ensuring that managers

maximize shareholder wealth
2. Costs are normally higher for MNCs than for
purely domestic firms for several reasons:
 Monitoring managers of distant subsidiaries in
foreign countries is more difficult.
 Foreign subsidiary managers raised in different
cultures may not follow uniform goals.
 Sheer size of larger MNCs can create large
agency problems.
 Some non-U.S. managers tend to downplay the short-term
effects of decisions.
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 Control of Agency Problems

1. Parent control of agency problems

Parent should clearly communicate the goals for each subsidiary
to ensure managers focus on maximizing the value of the
subsidiary.

2. Corporate control of agency problems

Entire management of the MNC must be focused on maximizing
shareholder wealth.
3. Sarbanes-Oxley Act (SOX)
Ensures a more transparent process for managers to report on the
productivity and financial condition of their firm.

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SOX Methods to Improve Reporting

 Establishing a centralized database of information

 Ensuring that all data are reported
consistently among subsidiaries
 Implementing a system that automatically checks
for unusual discrepancies relative to norms
 Speeding the process by which all departments
and subsidiaries have access to all the data they
need
 Making executives more accountable for
financial statements
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Management Structure of MNC

1. Centralized (See Exhibit 1.1a)

Allows managers of the parent to control
foreign subsidiaries and therefore reduce the
power of subsidiary managers
2. Decentralized (See Exhibit 1.1b)
Gives more control to subsidiary managers
who are closer to the subsidiary’s
operation
and environment
13 © 2015 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as
 Exhibit 1.1a Management Styles of MNCs

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 Exhibit 1.1b Management Styles of MNCs

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 Why Firms Pursue International Business

1. Theory of Competitive Advantage:

specialization increases production efficiency.
2. Imperfect Markets Theory: factors of production
are somewhat immobile providing incentive to seek
out foreign opportunities.
3. Product Cycle Theory: as a firm matures, it
recognizes opportunities outside its
domestic market.

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 Exhibit 1.2 International Product Life Cycles

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 How Firms Engage in International Business

1. International trade
2. Licensing
3. Franchising
4. Joint Ventures
5. Acquisitions of existing operations
6. Establishing new foreign subsidiaries

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 International Trade

 Relatively conservative approach that can be

used by firms to
 penetrate markets (by exporting)
 obtain supplies at a low cost (by importing).
 Minimal risk – no capital at risk
 The internet facilitates international trade by
allowing firms to advertise their products
and accept orders on their websites.

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Licensing

 Obligates a firm to provide its technology

(copyrights, patents, trademarks, or trade
names) in exchange for fees or some other
specified benefits.
 Allows firms to use their technology in foreign
markets without a major investment and
without transportation costs that result from
exporting
 Major disadvantage: difficult to ensure
quality control in foreign production process
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 Franchising

 Obligates firm to provide a specialized sales or

service strategy, support assistance, and possibly
an initial investment in the franchise in
exchange for periodic fees.
 Allows penetration into foreign markets without
a major investment in foreign countries.

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 Joint Ventures

 A venture that is jointly owned and operated by

two or more firms. A firm may enter the
foreign market by engaging in a joint venture
with firms that reside in those markets.
 Allows two firms to apply their respective
cooperative advantages in a given project.

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 Acquisitions of Existing Operations

 Acquisitions of firms in foreign countries allows

firms to have full control over their foreign
businesses and to quickly obtain a large portion
of foreign market share.
 Subject to the risk of large losses because of
larger investment.
 Liquidation may be difficult if the
foreign subsidiary performs poorly.

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 Establishing New Foreign Subsidiaries

 Firms can penetrate markets by establishing

new operations in foreign countries.
 Requires a large investment
 Acquiring new as opposed to buying existing
allows operations to be tailored exactly to
the firms needs.
 May require smaller investment than
buying existing firm.

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 Summary of Methods

 Any method of increasing international

business that requires a direct investment in
foreign operations is referred to as direct
foreign investment (DFI)
 International trade and licensing usually
not included
 Foreign acquisition and establishment of new
foreign subsidiaries represent the largest portion
of DFI.

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 Exhibit 1.3 Cash Flow Diagrams for MNCs

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Exhibit 1.3 Cash Flow Diagrams for MNCs

 The first diagram reflects an MNC that engages in

international trade. International cash flows result from
paying for imports or receiving cash flow from
exports.
 The second diagram reflects an MNC that engages in
some international arrangements. Outflows include
expenses such as expenses incurred from transferring
technology or funding partial investment in a franchise or
joint venture. Inflows are receipts from fees.
 The third diagram reflects an MNC that engages in
direct foreign investment. Cash flows exist between the
parent company and the foreign subsidiary.
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Valuation Model for an MNC:
Domestic Model

V  E CF$ 
 n ,t
 

t 1  1 k 
t


Where
 V represents present value of expected cash flows
 E(CF$,t) represents expected cash flows to be received at the
end of period t,
 n represents the number of periods into the future in which
cash flows are received, and
  k represents the required rate of return by investors.

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Valuation Model for an MNC:
Multinational Model

E
  E  E

CF $, j ,t
S
j ,t

 
t m

 CF
j 1
Where
 CFj,t represents the amount of cash flow denominated in a
particular foreign currency j at the end of period t,

 Sj,t represents 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.

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Valuation Model for an MNC
An MNC that uses two or more currencies

E
  E  E

CF $, j ,t
S
j ,t

 
t m

 CF
j 1
 Derive an expected dollar cash flow value for each currency
 Combine the cash flows among currencies within a
given period
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 Uncertainty Surrounding MNC Cash Flows

1. Exposure to international economic conditions – If

economic conditions in a foreign country weaken,
purchase of products decline and MNC sales in that
country may be lower than expected.
2. Exposure to international political risk – A foreign
government may increase taxes or impose barriers on
the MNC’s subsidiary.
3. Exposure to exchange rate risk – If foreign currencies
related to the MNC subsidiary weaken against the U.S.
dollar, the MNC will receive a lower amount of dollar
cash flows than was expected.

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 How Uncertainty Affects the MNC’s cost of Capital

A higher level of uncertainty increases the return on

investment required by investors and the MNC’s
valuation decreases.

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 Exhibit 1.4 How an MNC’s Valuation is Exposed to
Uncertainty

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 Exhibit 1.5 Organization of Chapters

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Summary

 The main goal of an MNC is to maximize shareholder

wealth. When managers are tempted to serve their own
interests instead of those of shareholders, an agency
problem exists. MNCs tend to experience greater
agency problems than do domestic firms. Proper
incentives and communication from the parent may help
to ensure that subsidiary managers focus on serving the
overall MNC.
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Summary

International business is justified by three key theories.

1. The theory of comparative advantage suggests that each
country should use its comparative advantage to
specialize in its production and rely on other countries
to meet other needs.
2. The imperfect markets theory suggests that because of
imperfect markets, factors of production are immobile,
which encourages countries to specialize based on the
resources they have.
3. The product cycle theory suggests that after firms are
established in their home countries, they commonly
expand their product specialization in foreign
countries.
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 Summary

 The most common methods by which firms conduct

international business are international trade, licensing,
franchising, joint ventures, acquisitions of foreign firms,
and formation of foreign subsidiaries. Methods such as
licensing and franchising involve little capital investment
but distribute some of the profits to other parties. The
acquisition of foreign firms and formation of foreign
subsidiaries require substantial capital investments but offer
the potential for large returns.

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 Summary

 The valuation model of an MNC shows that the MNC’s

value is favorably affected when its expected foreign
cash inflows increase, the currencies denominating those
cash inflows increase, or the MNC’s required rate of
return decreases. Conversely, the MNC’s value is
adversely affected when its expected foreign cash inflows
decrease, the values of currencies denominating those
cash flows decrease (assuming that they have net cash
inflows in foreign currencies), or the MNC’s required
rate of return increases.

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 Question to answer during lectures

1. Agency Problems of MNCs.

a. Explain the agency problem of MNCs.

b. Why might agency costs be larger for

an MNC than for a purely domestic firm?

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 Tutorial 1.Exercises for week 1 (tutorial 2). Please answer the following
questions and submit your answers via Mylo by Monday 9am

Total marks 10 (2 marks for each question)

1.Comparative Advantage.
a. Explain how the theory of comparative advantage relates to the need
for international business.
b. Explain how the product cycle theory relates to the growth of an MNC.

2.Imperfect Markets.
a. Explain how the existence of imperfect markets has led to the establishment of
subsidiaries in foreign markets.
b. If perfect markets existed, would wages, prices, and interest rates among countries be
more similar or less similar than under conditions of imperfect markets? Why?

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 3. Global Competition. Explain why more standardized product
specifications across countries can increase global competition

4. Exposure to Exhange Rates. McCanna Corp., a U.S. firm, has a

French subsidiary that produces wine and exports to various European
countries. All of the countries where it sells its wine use the euro as their
currency, which is the same as the currency used in France. Is McCanna
Corp. exposed to exchange rate risk?

5. Impact of Political Risk. Explain why political risk may discourage

international business.

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