International

Financial Management
Jeff Madura
10th Edition
Chapter 1:
Multinational Financial Management:
An Overview

1 Prepared By: M. Kashif Khurshid (Lecturer NUML)

 What is Finance?
 Finance can be defined as the art and science of managing the
money.
 Finance is concerned with the process, institutions, markets,
and instruments involved in the transfer of money among
individuals, businesses, and governments.
 The science that describes the management, creation and study of
money, banking, credit, investments, assets and liabilities. Finance
consists of financial systems, which include the public, private and
government spaces, and the study of finance and financial
instruments, which can relate to countless assets and liabilities.
Some prefer to divide finance into three distinct categories: public
finance, corporate finance and personal finance. All three of which
would contain many sub-categories.

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 DEFINITION OF INTERNATIONAL FINANCE
 International finance is the branch of economics that studies
the dynamics of foreign exchange, foreign direct investment
and how these affect international trade.
 It also includes the study of international projects,
international investments and the international capital flows.
 International finance (also referred to as
international monetary economics or international
macroeconomics) is the branch of financial
economics broadly concerned with monetary and
macroeconomic interrelations between two or
more countries
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 DEFINITION OF INTERNATIONAL FINANCE
 International Finance can be broadly defined, as the study of
the financial decisions taken by a multinational corporation in
the area of international business i.e. global corporate
finance.

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 REASONS TO STUDY INTERNATIONAL FINANCE
 To understand the global economy
 To understand the effect of Global Finance on business
 To make intelligent decisions

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 CLASSIFICATION OF INTERNATIONAL BUSINESS
OPERATIONS
The international business firms are broadly divided into three
categories:
(a) International Firm
(b) Multinational firm
(c) Transnational Firm
(a) International Firm
 The traditional activity of an international firm involves importing and
exporting. Goods are produced in the domestic market and then exported to
foreign buyers.
 Financial management problems of this basic international trade activity focus
on the payment process between the foreign buyer (seller) and domestic seller
(buyer).
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 CLASSIFICATION OF INTERNATIONAL BUSINESS
OPERATIONS
(b) Multinational firm
 As international business expands, the firm needs to be closer to the consumer, closer to
cheaper sources of inputs, or closer to other producers of the same product and gain
from their activities. It needs to produce abroad as well as sell abroad.
 As the domestic firm expands its operations across borders, incorporating activities in
other countries, it is classified as a multinational firm.
(c)Transnational Firm
 As the multinational firm expands its branches, affiliates, subsidiaries, and network of
suppliers, consumers, distributors and all others, which fall under the firm’s umbrella of
activities.
 Firms like Unilever, Phillips, Ford, and Sony have become intricate network with home
offices defined differently for products, processes, capitalization and even taxation.

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 Multinational Corporations
 Multinational corporations (MNCs) are defined as
firms that engage in some form of international business.
 Their managers conduct international financial management,
which involves international investing and financing decisions
those are intended to maximize the value of the MNC.
 The goal of their managers is to maximize the value of the
firm, which is similar to the goal of managers employed by
domestic companies.

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 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.

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 Goal of the MNC
 The commonly accepted goal of an MNC is to maximize
shareholders wealth.
 This book is focused on MNCs those are based in the United
States and wholly own their foreign subsidiaries.

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 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 subsidiaries.
 The sheer size of the MNC.
 The culture of foreign managers.
 Subsidiary value versus overall MNC value.

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 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 subsidiary’s operations and
environment.

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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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 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
parent’s management.
 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.

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 Impact of Management Control
 Various forms of corporate control can reduce agency costs.
 Stock compensation for board members and executives.
 The threat of a hostile takeover.
 Monitoring and intervention by large shareholders.

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 Constraints
Interfering with the MNC’s Goal
 As MNC managers attempt to maximize their firm’s value,
they may be confronted with various constraints.
 Environmental constraints.
 Regulatory constraints.
 Ethical constraints.

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 Theories of International Business
Why are firms motivated to expand their
business internationally?
Theory of Comparative Advantage:
 Specialization by countries can increase production efficiency.
Imperfect Markets Theory:
 The markets for the various resources used in production are
“imperfect.”
Product Cycle Theory:
 As a firm matures, it may recognize additional opportunities
outside its home country.

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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 and
product from foreign business possibly to
competitors and/or declines as its reduce costs.
expands product competitive
line in foreign advantages are
country. eliminated.
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 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.

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 International
Business Methods
 Licensing allows a firm to provide its technology in exchange
for fees or some other benefits.
 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.

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 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.
 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.

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 International
Business Methods
 Firms can also penetrate foreign markets by establishing new
foreign subsidiaries.
 In general, any method of conducting business that requires a
direct investment in foreign operations is referred to as a
direct foreign investment (DFI).
 The optimal international business method may depend on
the characteristics of the MNC.

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 International Opportunities
 Investment opportunities - The marginal return on projects
for an MNC is above that of a purely domestic firm because
of the expanded opportunity set of possible projects from
which to select.
 Financing opportunities - An MNC is also able to obtain
capital funding at a lower cost due to its larger opportunity
set of funding sources around the world.

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 Exposure to International Risk
International business usually increases an MNC’s
exposure to:
 exchange rate movements
 Exchange rate fluctuations affect cash flows and foreign
demand.
 foreign economies
 Economic conditions affect demand.
 political risk
 Political actions affect cash flows.

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 Managing for Value
 Like domestic projects, foreign projects involve an
investment decision and a financing decision.
 When managers make multinational finance decisions that
maximize the overall present value of future cash flows, they
maximize the firm’s value, and hence shareholder wealth.

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 Valuation Model for an MNC
 Domestic Model

n
E CF$, t 
Value = 
t =1 1 k t

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 by investors

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 Valuation Model for an MNC
 Valuing International Cash Flows

m 
n 
E CF j, t   E ER 
j, t 
 j 1 
Value =   
t =1  1  k  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 of the U.S. parent
company
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 Valuation Model for an MNC
 An MNC’s financial decisions include how much business to
conduct in each country and how much financing to obtain in
each currency.
 Its financial decisions determine its exposure to the
international environment.

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 Valuation Model for an MNC
Impact of New International Opportunities
on an MNC’s Value

Exposure to
Foreign Economies Exchange Rate Risk

m 
n 
E CFj , t  E ER j , t 
 j 1 
Value =   
t =1  1  k  t

 

Political Risk
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 How Chapters Relate to Valuation
Exchange Rate
Exchange Rate Risk
Behavior
Management
(Chapters 6-8)
(Chapters 9-12)
Background
on Long-Term
International Investment and Risk and Value and
Financial Financing Return of Stock Price
Markets Decisions MNC of MNC
(Chapters (Chapters 13-18)
2-5)

Short-Term
Investment and
Financing
Decisions
(Chapters 19-21)
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 Chapter Review
 Goal of the MNC
 Conflicts Against the MNC Goal
 Impact of Management Control
 Impact of Corporate Control
 Constraints Interfering with the MNC’s Goal
 Theories of International Business
 Theory of Comparative Advantage
 Imperfect Markets Theory
 Product Cycle Theory

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 Chapter Review
 International Business Methods:
 International Trade
 Licensing
 Franchising
 Joint Ventures
 Acquisitions of Existing Operations
 Establishing New Foreign Subsidiaries

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 Chapter Review
 Exposure to International Risk
 Exposure to Exchange Rate Movements
 Exposure to Foreign Economies
 Exposure to Political Risk
 Managing for Value

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 Chapter Review
 Valuation Model for an MNC
 Domestic Model
 Valuing International Cash Flows
 Impact of Financial Management and International Conditions
on Value
 How Chapters Relate to Valuation

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