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Working Capital Management for the Multinational Corporation

International Financial Management


Dr. A. DeMaskey

Learning Objectives

How does multinational working capital management differ from domestic working capital management? What are the objectives of international cash management? What techniques are used by MNCs for making cross-border payments? What key factors are associated with a firms funding strategy? What short-term financing options are available?

Multinational Working Capital Management

Funds Availability Additional Risks Movement of Capital Decisions Taxes

International Cash Management

A set of activities, which consists of:

Cash management - the levels of cash balances held throughout the MNC Cash settlements and processing - the facilitation of its movement across borders

Cash Management

Cash levels are determined independently of working capital management decisions

Cash balances, including marketable securities, are held partly for day-to-day transactions and to protect against unanticipated variations from budgeted cash flows These two motives are called the transaction motive and the precautionary motive.

International Cash Management

Goal: Minimize cash balances without reducing operations or increasing risk. Steps:

Cash Planning - anticipating cash flows over future days, weeks, or months. Cash Collection getting cash into the firm as soon as possible. Cash Mobilization moving cash within the firm to the location where needed. Cash Disbursements planning procedures for distributing cash. Covering Cash Shortages managing anticipated cash shortages by borrowing locally. Investing Surplus Cash managing anticipated cash surpluses by investing locally or controlling them centrally.

Cash Positioning Decision

Currency of location Type of liquid asset held

Maturities, yields, and liquidity characteristics

Objectives of an Effective Cash Management System

Minimizing overall cash requirements Minimizing currency exposure risk Minimizing political risk Minimizing transactions costs Taking full advantage of economies of scale

Complexities of the International Cash Positioning Decision

Conflicting nature of cash management objectives Government restrictions Multiple taxation systems Multiple currencies

International Cash Settlements and Processing

Four techniques for simplifying and lowering the cost of settling cash flows between related and unrelated firms

Wire transfers Cash pooling Payment netting Electronic fund transfers

Wire Transfers

Variety of methods but two most popular for cash settlements are CHIPS and SWIFT

CHIPS is the Clearing House Interbank Payment System owned and operated by its member banks SWIFT is the Society for Worldwide Interbank Financial Telecommunications which also facilitates the wire transfer settlement process Whereas CHIPS actually clears transactions, SWIFT is purely a communications system

Cash Pooling and Centralized Depositories

Key: Centralizing the cash positioning function to gain operational benefits.

Subsidiaries hold minimum cash for their own transactions and no cash for precautionary purposes All excess funds are remitted to a central cash depository

Centralized depositories provide the following advantages:


Information advantage is attained by central depository on currency movements and interest rate risk Precautionary balance advantages as MNC can reduce pool without any loss in level of protection Interest rate advantages as funds can be borrowed at a lower cost and invested at a more advantageous rate. Location can provide tax benefits, access to international communications, clearly defined legal procedures.

Multilateral Netting

Netting involves offsetting receivables against payables so that only the net amounts are transferred among affiliates. Types

Bilateral netting Multilateral netting

Payments netting is useful primarily when a large number of separate foreign exchange transactions occur between subsidiaries.

Payments Netting

Example: A Belgian affiliate owes an Italian affiliate $5,000,000, while the Italian affiliate simultaneously owes the Belgian affiliate $3,000,000.

Bilateral settlement calls for $2,000,000 payment from Belgium to Italy and cancellation of the remainder via offset. Multilateral netting is an extension of bilateral netting.

Assume that payments are due between Apexs European operations each month. Without netting Apex de France would make three separate transactions each way.

Financing Working Capital

Financing working capital requirements of a MNCs foreign affiliates poses a complex decision problem. Financing options for a subsidiary include:

Intercompany loans from the parent or a sister affiliate. Local currency financing.

Key Factors Underlying the Funding Strategy

Interest Rate

Without forward contracts With forward contracts

Exchange Risk Degree of Risk Aversion Taxes Political Risk

Financing Objectives

Minimize covered after-tax interest costs Minimize expects costs Trade-off between expected cost and reducing the degree of cash flow exposure

Intercompany Loans

The cost of an intercompany loan is determined by the following factors:


Opportunity cost of funds Interest rate Tax rates and regulations Currency of denomination Expected exchange rate change

Local Currency Financing

Bank Loans

Term Loans Line of Credit Overdraft Revolving Credit Agreement Discounting

Commercial Paper

Effective Interest Rate on Bank Loans

Simple interest loan Discount loan Loan with compensating balance requirement

Simple interest loan Discount loan

Effective Annual Percentage Cost Illustration

The Olivera Corporation, a manufacturer of olive oil products, needs to acquire 1 million in funds today to expand a pimiento-stuffing facility. Banca di Roma has offered them a choice of an 11% loan payable at maturity or a 10% loan on a discount basis. Which loan should Olivera choose?

Calculating the Dollar Costs of Alternative Financing Options

In deciding on a particular financing option, a firm needs to estimate and then compare the effective after-tax dollar costs of local currency financing and dollar financing.

In reality, the value of the currency borrowed will most likely change with respect to the borrowers local currency over time. Breakeven analysis can be used to determine the least expensive financing source for each future exchange rate.

Effective Financing Rate: No Taxes

Suppose that Ford has an affiliate in Mexico, which can borrow pesos at 80% or dollars at 12% for one year.

If the peso is expected to devalue from MP$ 7.50/$ at the beginning of the year to MP$ 10.23/$ at the end of the year, what is the expected before-tax dollar cost of the peso loan? What is the cost of the dollar loan to Ford? What is the breakeven rate of currency change at which the dollar cost of borrowing pesos is just equal to the cost of dollar financing?

Effective Financing Rate: No Taxes

Dollar cost of local currency (LC) loan

rH (LC) = rL (1 + c) + c

Cost of dollar loan (HC)

rH (HC) = rH

Breakeven rate of currency change

rL (1 + c) + c = rH

Effective Financing Rate: With Taxes

Suppose the Mexican corporate tax rate is 53%.

What is the expected after-tax dollar cost of borrowing pesos? What is the expected after-tax cost of the dollar loan? What is the breakeven rate of currency change at which the after-tax dollar cost of local currency financing is just equal to the after-tax cost of dollar financing?

Effective Financing Rate: With Taxes

After-tax dollar cost of borrowing local currency

rH (LC) = rL (1 - Ta)(1 + c) + c

After-tax cost of dollar loan

rH (HC) = rH (1 - Ta) + cTa

Breakeven rate of currency change

rL(1 - Ta)(1 + c) + c = rH(1 - Ta) + cTa