Daniel 78

Part Six
Managing International Operations
Chapter Nineteen
The Multinational Finance
Function
19-1
Copyright © 2009 Pearson Education, Inc. publishing as Prentice Hall
Chapter Objectives
• To describe the multinational finance function and how it
fits in the MNE’s organizational structure
• To show how companies can acquire outside funds for
normal operations and expansion, including offshore
debt and equity funds
• To explore how offshore financial centers are used to
raise funds and manage cash flows
• To explain how companies include international factors in
the capital budgeting process
• To discuss the major internal sources of funds available
to the MNE and to show how these funds are managed
globally
• To describe how companies protect against the major
financial risks of inflation and exchange-rate movements
19-2
The Finance Function
• The corporate finance function acquires and
allocates financial resources among the
company’s activities and projects. Four key
functions are:
 Capital structure.
 Long-term financing.
 Capital budgeting.
 Working capital management.
• The CFO acquires financial resources and
allocates them among the company’s activities
and projects.
19-3
Capital Structure
• Capital structure of the company is the mix
between long-term debt and equity
• Leverage is the degree to which a firm
funds the growth of business by debt.
• The amount of leverage used varies from
country to country.
19-4
Factors that Influence the Choice of
Capital Structure
• Choice of capital structure depends on:
 tax rates
 degree of development of local equity markets
 creditor rights
• Companies can use local and international
debt markets to raise funds.
19-5
Global Capital Markets
• Two major sources of funds external to the
MNE’s normal operations are debt
markets and equity markets.
19-6
Eurocurrencies
• A Eurocurrency is any currency banked outside
its country of origin, but it is primarily dollars
banked outside the United States
• Four major sources of Eurocurrencies:
 Foreign governments or individuals who want to hold
dollars outside the United States
 Multinational enterprises that have cash in excess of
current needs
 European banks with foreign currency in excess of
current needs
 Countries such as Germany, Japan, and Taiwan that
have large balance-of-trade surpluses held as
reserves
19-7
International Bonds
• A foreign bond is one sold outside the
country of the borrower but denominated
in the currency of the country of issue
• A Eurobond, also called a global bond, is a
bond issue sold in a currency other than
that of the country of issue
19-8
Equity Securities and the Euroequity
Market
• The three largest stock markets in the
world are in New York, Tokyo, and London,
with the U.S. markets controlling nearly
half of the world’s stock market
capitalization.
• Euroequities are shares listed on stock
exchanges in countries other than the
home country of the issuing company
19-9
American Depositary Receipts
(ADRs)
• Most foreign companies that list on the
U.S. stock exchanges do so through
American Depositary Receipts, which are
financial documents that represent a share
or part of a share of stock in the foreign
company
• ADRs are easier to trade on the U.S.
exchanges than are foreign shares
19-10
Offshore Financial Centers
• Offshore financing is the provision of financial
services by banks and other agents to
nonresidents.
• Offshore financial centers are cities or countries
that provide large amounts of funds in
currencies other than their own.
• OFCs offer low or zero taxation, moderate or
light financial regulation, and banking secrecy
and anonymity.
• The OECD is trying to eliminate the harmful tax
practices in tax-haven countries.
19-11
Capital Budgeting in a Global
Context
• Capital budgeting is the process whereby
MNEs determine which projects and
countries will receive capital investment
funds.
19-12
Methods Of Capital Budgeting
• Capital budgeting techniques:
 Payback period.
 Net present value of a project.
 Internal rate of return.
• MNEs need to determine free cash flows based
on cash flow estimates and tax rates in different
countries and an appropriate required rate of
return adjusted for risk.
• Two ways to deal with the variations in future
cash flows: determine several different scenarios
or adjust the hurdle rate
19-13
Internal Sources of Funds
• Funds are working capital, or current
assets minus current liabilities.
• Sources of internal funds are:
 Loans.
 Investments through equity capital.
 Intercompany receivables and payables.
 Dividends.
19-14
Global Cash Management
• Cash budgets and forecasts are essential in
assessing a company’s cash needs.
• Dividends are a good source of intercompany
transfers, but governments often restrict their
free movement.
• Multilateral netting is the process of coordinating
cash inflows and outflows among subsidiaries so
that only net cash is transferred, reducing
transaction costs.
• Netting requires sophisticated software and
good banking relationships in different countries.
19-15
Foreign-Exchange Risk Management
• Translation exposure arises because the dollar value of
the exposed asset or liability changes as the exchange
rate changes.
• Transaction exposure arises because the receivable or
payable changes in value as the exchange rate changes.
• Economic, or operating, exposure arises from effects of
exchange-rate changes on:
 Future cash flows.
 The sourcing of parts and components.
 The location of investments.
 The competitive position of the company in different markets.
19-16
Exposure-Management Strategy
• To protect assets from exchange-rate risk,
management needs to:
 Define and measure exposure.
 Establish a reporting system.
 Adopt an overall policy on exposure
management.
 Formulate hedging strategies.
19-17
Formulating Hedging Strategies
• Hedging strategies can be operational or
financial.
• Operational strategies include:
 Using local debt to balance local assets.
 Taking advantage of leads and lags for intercompany
payments.
• Forward contracts can establish a fixed
exchange rate for future transactions.
• Currency options can ensure access to foreign
currency at a fixed exchange rate for a specific
period of time.
19-18
Taxation of Foreign Source Income
• Tax planning influences profitability and cash flow.
• Taxation has a strong impact on several choices:
 Location of operations
 Choice of operating form, such as export or import, licensing
agreement, overseas investment
 Legal form of the new enterprise, such as branch or subsidiary
 Possible facilities in tax-haven countries to raise capital and
manage cash
 Method of financing, such as internal or external sourcing and
debt or equity
 Capital budgeting decisions
 Method of setting transfer prices
19-19
International Tax Practices
• Problems with different countries’ tax practices
arise from:
 Lack of familiarity with laws.
 Loose enforcement.
• With a value-added tax, each company pays a
percentage of the value added to a product at
each stage of the business process.
• Corporate tax rates vary from country to country.
19-20
Approaches to Corporate Taxation
• In the separate entity approach,

governments tax each taxable entity when
it earns income.
• An integrated system tries to avoid double
taxation of corporate income through split
tax rates or tax credits.
19-21
Taxing Branches And Subsidiaries
• Foreign branch income (or loss) is directly
included in the parent’s taxable income.
• Tax deferral means that income from a
subsidiary is not taxed until it is remitted to the
parent company as a dividend.
• In a CFC, U.S. shareholders hold more than 50
percent of the voting stock.
• Active income is derived from the direct conduct
of a trade or business. Passive income (also
called Subpart F income) usually is derived from
operations in a tax-haven country.
19-22
Transfer Prices
• A transfer price is a price on goods and
services one member of a corporate family
sells to another.
• The OECD has set transfer pricing
guidelines to eliminate the manipulation of
prices and, therefore, taxes for MNEs.
19-23
Double Taxation and Tax Credit
• The IRS allows a tax credit for corporate

income tax U.S. companies pay to another
country. A tax credit is a dollar-for-dollar
reduction of tax liability and must coincide
with the recognition of income.
• The purpose of tax treaties is to prevent
double taxation or to provide remedies
when it occurs.
19-24

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Part Six

Managing International Operations

• In the separate entity approach,

• The IRS allows a tax credit for corporate

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