Chapter # 1

Introduction :
International Financial Management
Multinational corporations (MNCs) are defined as firms that engage in some form of international business.
 Multinational • IBM, Nike, and many other firms
corporations (MNCs) have more than half of their assets in
foreign countries.
• Multinational corporations (MNCs)
are defined as firms that engage in • Fortune Brands, and Colgate
some form of international business. Palmolive, commonly generate more
• International financial management,
(IFM) which involves international
than half of their sales in foreign
investing and financing decisions countries.
that are intended to maximize the
value of the MNC. • Coca-Cola Co., which distributes its
• International financial management
is important even to companies that
products in more than 160 countries
have no international business and uses 40 different currencies.
because these companies must
recognize how their foreign Over 60 percent of its total annual
competitors will be affected by
movements in exchange rates,
operating income is typically
foreign interest rates, labor costs, generated outside the United States.
and inflation.
 (MNCs) Facing
Agency Problems
• The conflict of goals between a
firm’s manager and shareholders
is often referred to as the agency
problem
• MNCs faced problems due to:
• First, MNCs with scattered
subsidiaries
• Second, different cultures of
foreign subsidiary managers
• Third, larger MNCs creates
large agency problems
• Parent Control of Agency Problems.
• The parent corporation of an MNC can prevent agency
problems with proper governance such as by clearly
communicating the goals (Yahoo & AliBaba),
• The parent can also implement compensation plans that reward
the subsidiary managers who satisfy the MNC’s goals. (apple &
cook)
• Corporate Control of Agency Problems.
• Corporate control can prevent agency problems by ensuring
that managers make decisions to satisfy the MNC’s
shareholders.
• They can even remove managers and keep their valuable
shareholders with firm
• Firm’s board members monitor the financial reporting process
to avoid manipulation by managers
• Management Structure of an MNC
• A centralized management style of parent company reduces
agency costs & reduces the power of subsidiary managers.
• If subsidiary managers recognize the goal of maximizing value of
the overall MNC in accordance with that goal, the decentralized
management style may be more effective.
 Why Firms Pursue
International Business
• (1) The Theory Of
Comparative Advantage,
• Japan and the United States
are large producers of
computer components,
• Jamaica and Mexico are
large producers of
agricultural and handmade
goods
• China has high quality low
cost labour than U.S
• Sony Japan based company
designed products at home
manufacture at Malaysia
• (2) The Imperfect Markets Theory
• Markets for the various resources used in
production are “imperfect,” MNCs such as the Gap
and Nike often capitalize on a foreign country’s
resources. Imperfect markets provide an incentive
for firms to seek out foreign opportunities.
• Europe restricting Japanese automobiles, so japan
opened their own plants
• (3) The product cycle theory
• Foreign demand for the firm’s product will initially
be accommodated by exporting. As time passes,
the firm may feel the only way to retain its
advantage over competition in foreign countries is
to produce the product in foreign markets, thereby
reducing its transportation costs. Whirlpool,
general electric start from U.S
International Product Life Cycle
 How Firms Engage in • International Trade: Firms to penetrate
International Business markets (by exporting) or to obtain
supplies at a low cost (by importing).
• International trade • Minimal risk due to capital at parent company.
• General Electric, and IBM, generate more than $4 billion
• Licensing in annual sales from exporting.
• Many firms are using e-business techniques. Walmart
• Franchising
• Licensing: Licensing obligates a firm to provide its
• Joint ventures technology (copyrights, patents, trademarks, or
trade names) in exchange for fees or some other
• Acquisitions of existing operations specified benefits. Pharma products
• For example, AT&T and Verizon Communications have
• Establishing new foreign subsidiaries licensing agreements to build and operate parts of
India’s telephone system.
• A major disadvantage of licensing technology is to
ensure quality control in the foreign production process.
 How Firms Engage in • Franchising: Franchising obligates a firm to
International Business provide a specialized sales or service strategy,
support assistance, and possibly an initial
• International trade
investment in the franchise in exchange for
periodic fees. For example, McDonald’s, Pizza
• Licensing Hut, have franchises that are owned and
managed by local residents in many foreign
• Franchising countries.
• Joint ventures • Joint Ventures: A joint venture is a venture
that is jointly owned and operated by two or
• Acquisitions of existing operations
more firms by joining their respective
• Establishing new foreign subsidiaries comparative advantages.
• GM in China
• For example, General Mills, Inc., joined in a
venture with Nestlé SA.
• Xerox Corp. and Fuji Co. (of Japan)
 • Acquisitions of Existing Operations: Firms
How Firms Engage in frequently acquire other firms in foreign
countries as a means of penetrating foreign
International Business markets.
• For example Procter & Gamble purchased a bleach
• International trade company in Panama. Honda with hero bikes, india
• It allow full control over foreign businesses & large
• Licensing portion of foreign market share.
• An acquisition is risky due to large investment.
• Franchising
• Poor foreign operations decrease firm value
• Joint ventures • Acquisitions may be partial or full.

• Acquisitions of existing operations

• Establishing New Foreign Subsidiaries: Firms
penetrate foreign markets by establishing
• Establishing new foreign subsidiaries new operations in foreign countries to
produce and sell their products.
• Firm can be operated as per firm’s need.
• Smaller investment needed than to purchase
existing operations. Oracle, CitiBank(CitiCorp)
Cash Flow Diagrams for MNCs
 Valuation Model
for an MNC • Valuing International Cash Flows

• Domestic Model
• where CFj,t represents the amount of cash flow
• Value domestic firm that does not engage in any
denominated in a particular foreign currency j at
foreign transaction
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
• where E(CF$,t) represents expected cash flows to
at the end of period t.
be received at the end of period t,

• n represents the number of periods,

• k represents the required rate of return by investor

• Valuation of an MNC That Uses Many Currencies.

• Licensing • where CFj,t represents the cash flow denominated in a

particular currency (including dollars),
• Sj,t represents the exchange rate at which the MNC can
convert the foreign currency at the end of period t.
 • Exposure to International Economic Conditions.
Uncertainty Surrounding • If economic conditions of any country weaken,
MNC’s sales in that country may be lower than
an MNC’s Cash Flows expected. This results in a reduction in the MNC’s
cash flows, and therefore in its value. (Europe &
US)
• The MNC’s future cash flows are
• Exposure to International Political Risk.
subject to uncertainty because of its • Political risk (also called country risk) arise due to
exposure to increase taxes or impose barriers on the MNC’s
subsidiary. (Russia & Venezuela )
• International economic conditions,
• Exposure to Exchange Rate Risk.
• Political conditions,
• If the foreign currencies to be received by a U.S.-
• And exchange rate risk based MNC suddenly weaken against the dollar,
the MNC will receive a lower amount of dollar
cash flows than was expected. This may reduce
the value of the MNC.