Chapter

1
Multinational Financial Management:
An Overview
1. What is the appropriate definition of an MNC?

2. Why does an MNC expand internationally?

3. What are the risks of an MNC which expands

internationally?

4. Why do you think European countries attract

U.S. firms? OR Why do you think Asian countries
attract Chinese firms?

5. Why must purely domestic firms be concerned

about the international environment?
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 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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 Definition of MNCs

Firms that are engage in some

form of international business.

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 Managing the MNC

• The commonly accepted goal of an MNC is

to maximize shareholder wealth.
• We will focus on MNCs that are based in
the United States and that wholly own
their foreign subsidiaries.

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 Managing the MNC

How Business Disciplines Are Used to Manage

the MNC
▪ Common finance decisions include:
▪ Whether to discontinue operations in a particular country
▪ Whether to pursue new business in a particular country
▪ Whether to expand business in a particular country
▪ How to finance expansion in a particular country
▪ Finance decisions are influenced by other
business discipline functions:
▪ Marketing
▪ Management
▪ Accounting and information systems

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 Conflicts Against the MNC Goal
• The conflict of goals between managers and
shareholders
• 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.

• Parent control of agency problems

• Corporate control of agency problems
• Sarbanes-Oxley Act (SOX)
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 Impact of Management Control
▪ Centralized
▪ Allows managers of the parent to control foreign
subsidiaries and therefore reduce the power of subsidiary
managers
▪ Decentralized
▪ Gives more control to subsidiary managers who are closer
to the subsidiary’s operation and environment
▪ How the Internet Facilitates Management Control
▪ Makes it easier for parent to monitor the actions and
performance of its foreign subsidiaries

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Centralized Multinational Financial Management
for an MNC with two subsidiaries, A and B

Cash Financial Cash

Management Managers Management
at A of Parent at B

Inventory and Inventory and

Accounts Accounts
Receivable Receivable
Management at A Management at B

Financing at A Financing at B

Capital Expenditures Capital Expenditures

at A at B
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Decentralized Multinational Financial Management
for an MNC with two subsidiaries, A and B

Cash Financial Financial Cash

Management Managers Managers Management
at A of A of B at B

Inventory and Inventory and

Accounts Accounts
Receivable Receivable
Management at A Management at B

Financing at A Financing at B

Capital Expenditures Capital Expenditures

at A at B
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 Theories of International Business
Why are firms motivated to expand
their business internationally?

1. Theory of Comparative 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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 The International Product Life Cycle

 Firm creates  Firm exports

product to product to  Firm
accommodate accommodate establishes
local demand. foreign demand. foreign
subsidiary
to establish
presence in
a. Firm or foreign
differentiates b. Firm’s country
product from foreign and
competitors business possibly to
and/or expands declines as its reduce
product line in competitive costs.
foreign country. advantages are
eliminated.
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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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 How Firms Engage in International Business

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

• How the Internet Facilitates International Trade

¤ The internet facilitates international trade by allowing
firms to advertise their products and accept orders on
their websites.
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 How Firms Engage in International Business

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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 How Firms Engage in International Business
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.
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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 How Firms Engage in International Business

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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 How Firms Engage in International Business

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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Overview of an MNC’s Cash Flows

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 Valuation Model for an MNC:

Domestic Model
n
 E (CF$,t )
V =  t 
t =1  (1 + k ) 

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:

Domestic Model (cont.)

▪ Dollar Cash Flows
▪ The dollar cash flows in period t represent funds received
by the firm minus funds needed to pay expenses or taxes
or to reinvest in the firm.
▪ Cost of Capital
▪ The required rate of return (k) in the denominator of the
valuation equation.
▪ A weighted average of the cost of capital based on all the
firms projects.

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 Valuation Model for an MNC:

Multinational Modell


E (CF$,t ) =  E (CF j ,t ) E (S j ,t ) 
m

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:

Multinational Model (cont.)

▪ Valuation of an MNC that uses two currencies
▪ Could measure its expected dollar cash flows in any
period by multiplying the expected cash flow in each
currency by the expected exchange rate at which that
currency would be converted to dollars and then
summing those two products.
▪ Valuation of an MNC that uses multiple currencies


E (CF$,t ) =  E (CF j ,t ) E (S j ,t ) 
m

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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 Valuation Model for an MNC:

Multinational Model (cont.)

▪ Valuation of an MNC’s cash flows over multiple
periods
▪ Apply single period process to all future periods
▪ Discount the estimated total dollar cash flow for each
period at the weighted cost of capital

 E (CF ) E (S )
m

n j ,t j ,t

V =
j =1

t =1 (1 + k ) 2

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 Valuation Model for an MNC:

Uncertainty Surrounding MNC Cash Flows

▪ 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.
▪ Exposure to international political risk – A foreign
government may increase taxes or impose barriers on the
MNC’s subsidiary.
▪ 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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Exhibit 1.4 How an MNC’s Valuation is Exposed to
Uncertainty

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Exhibit 1.5 Potential Effects of International Economic
Conditions

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How Uncertainty Affects the MNC’s cost of Capital

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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