Introduction to International

Financial Management

PowerPoint Lecture Presentation

to
to accompany
accompany
International
International Financial
Financial Management
Management
Dr.
Dr. Samiul
Samiul Parvez
Parvez Ahmed,
Ahmed, Faculty,
Faculty, Independent
Independent University,
University, Bangladesh
Bangladesh

Part I

The International Financial Environment

Multinational Corporation (MNC)

Foreign Exchange Markets

Exporting
& Importing
Product Markets

Dividend
Remittance
& Financing

Subsidiaries

Investing
& Financing
International
Financial
Markets

Chapter

Multinational Financial Management:

An Overview

Chapter Objectives
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.

To provide a model for valuing the MNC

Multinational Corporations (MNCs)

MNCs are defined as firms that engage in
some form of international business.

Their managers conduct international

financial management.

Goal of the MNC

The commonly accepted goal of an MNC is
to maximize shareholder wealth (measured
by share price).

Functions of Financial Management

Acquisition of funds: generating funds

(internally or externally) at a lowest possible
cost
Investment of funds: invest funds in such a
way that increases wealth

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 scattering of distant subsidiariesdifficult to monitor
The culture of foreign managers may be different and they may
not follow uniform goals
The sheer size of the MNC.
Subsidiary value (e.g. serve local employees welfare) versus
overall MNC value.

Impact of Management Control

The magnitude of agency costs can vary
with the management style of the MNC.

A centralized management style reduces

agency costs. However, a decentralized
style gives more control to those
managers who are closer to the
subsidiarys operations and environment.

Centralized Multinational Financial Management

for an MNC with two subsidiaries, A and B
Cash
Management
at A
Inventory and
Accounts
Receivable
Management at A
Financing at A
Capital Expenditures
at A

Financial
Managers
of Parent

Cash
Management
at B
Inventory and
Accounts
Receivable
Management at B
Financing at B
Capital Expenditures
at B

Decentralized Multinational Financial Management

for an MNC with two subsidiaries, A and B
Cash
Management
at A

Financial
Managers
of A

Inventory and
Accounts
Receivable
Management at A
Financing at A
Capital Expenditures
at A

Financial
Managers
of B

Cash
Management
at B
Inventory and
Accounts
Receivable
Management at B
Financing at B

Capital Expenditures
at B

Impact of Management Control

Some MNCs attempt to strike a balance they allow subsidiary managers to make
the key decisions for their respective
operations, but the decisions are
monitored by the parents management.

Impact of Management Control

Electronic networks make it easier for the
parent to monitor the actions and
performance of foreign subsidiaries.

For example, corporate intranet or internet

email facilitates communication. Financial
reports and other documents can be sent
electronically too.

Impact of Corporate Control

Various forms of corporate control can reduce
agency costs.
Stock compensation (e.g. options to buy stocks)
for board members and executives.
The threat of a hostile takeovernew
shareholders can remove the old managers
Monitoring and intervention by large
shareholders (e.g. mutual funds or pension
funds).

Theories of International Business

Why are firms motivated to expand
their business internationally?
Theory of Comparative Advantage

Specialization by countries can increase production efficiency.

E.g. USA and Japan have technological advantages;
Bangladesh, India, China have advantage on basic labor cost
Specialization and Gains from Tradecountry having
comparative advantage in making a good would be able to
produce it at a lower (opportunity) cost

Theories of International Business

Imperfect Markets Theory

The markets for the various resources used in

production are imperfect.factors of production are
immobile (e.g. labor cannot freely move, land is
immobile)
Many foreign firms established their production units in
countries where the cost of labor and land are cheaper.

Theories of International Business

Imperfect Markets Theory
Arbitrage (due to imperfect market pricing):
Traditionally has been defined as the purchase
of assets or commodities on one market for
immediate resale on another in order to
profit from a price discrepancy. In recent
years, arbitrage has been used to describe a
broader range of activities: tax arbitrage.

Theories of International Business

Product Cycle Theory

As a firm matures, it may recognize

additional opportunities outside its home
country.

The International Product Life Cycle

Firm creates
product to
accommodate
local demand.
a. Firm
differentiates
product from
competitors
and/or expands
product line in
foreign country.

Firm exports
product to
accommodate
foreign demand.

b. Firms foreign
business declines
as its competitive
advantages are
eliminated (e.g.
over time,
competition rises
as others are
familiar with the
products)

or

Firm
establishes
foreign
subsidiary
to establish
presence in
foreign
country &
possibly to
reduce
costs (e.g.
transport
cost)

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 (e.g.
copyrights, patents, trademarks) in exchange for fees or
some other benefits. Licensing allows firms to use their
technology in foreign markets without major investment in
foreign countries.

The major disadvantage in licensing is that it is often

difficult to control the quality of the product/service. (e.g.
American Standard International School in Bangladesh is
licensed by American Education Group; this institute can
use American curriculums, books teaching methods etc.)

International
Business Methods
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. (e.g. Subway, Nandos).

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. E.g.
GrameenPhone is a joint venture by
Telenor (Norway) and Grameen Telecom
Corporation.

International
Business Methods
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.
Usually, poor performers sell their existing businesses to
others. It is relatively (compare to developing own
subsidiary) a cheaper option to penetrate foreign market.

E.g. Google Inc. acquired business in Australia (search

engines), Brazil (search engines), Canada (Mobile
Browser), China (search engines) etc.

International
Business Methods
Firms can also penetrate foreign markets
by establishing new foreign subsidiaries.
It requires a large investment.

International
Business Methods
In general, any method of conducting
business that requires a direct investment
in foreign operations is referred to as a
direct foreign investment (DFI).

Cash Flow Diagram for MNCs

Cash Inflows Received from
selling products

Domestic
Business
Activities

Internatio
nal Trade
Activities

Cash outflows to pay wages

Cash outflows to buy
supplies and materials

Local Customers
Local Employees
Local Businesses

Cash Inflows Received from

selling products

Foreign Importers
Cash outflows to buy
supplies and materials

Foreign Exporters

Cash Flow Diagram for MNCs

Licensing,
Franchisi
ng & Joint
Ventures

Cash Inflows for service

provided
Cash outflows for service
received

Foreign Firms

Cash Inflows from remitted

earnings

Investment
Investment
in
in Foreign
Foreign
Subsidiaries
Subsidiaries

Foreign
Subsidiaries
Cash outflows to provide
financing for foreign
subsidiaries

Factors Unique to MNCs

Exchange rate
Multiple inflation rates
International differences in tax rates
Multiple money markets
Currency controls
Multiple political situations

Risks as Advantages!!!
Taking advantages by MNCs (Being a large
global firm)
Ability to mobile people, money and material
Access segmented capital and money markets
Economic/political differences---International
diversification opportunities
Information updates continuously --- in relation to
technical/research advancement of its
competitors
Higher bargaining power while negotiating with
foreign governments---due to its sheer size!!!

Valuation Model for an MNC

Domestic Model
n

Value =
t =1

E CF$, t

1 k

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

Valuation Model for an MNC

Valuing International Cash Flows

E CF E ER

Value =
t =1

j 1

j, t

1 k

j, 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

Valuation Model for an MNC

Impact of New International Opportunities
on an MNCs Value
Uncertain foreign currency
cash flows due to uncertain
foreign economic & political
conditions

Exchange Rate Risk

E CF E ER

Value =
t =1

j 1

j, t

1 k

j, t

How Chapters Relate to Valuation

Exchange Rate
Behavior
(Chapters 6-8)
*7,8
Background
on
International
Financial
Markets
(Chapters
2-5)
*1,4,5

Long-Term
Investment and
Financing
Decisions
(Chapters 13-18)
*14,17
Short-Term
Investment and
Financing
Decisions
(Chapters 19-21)

Exchange Rate
Risk Management
(Chapters 9-12) *9

Risk and
Return of
MNC

Value and
Stock Price
of MNC