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Part IThe International Financial Environment
Multinational Corporation (MNC)
Foreign Exchange Markets
Product Markets Subsidiaries InternationalFinancialMarkets
DividendRemittance& FinancingExporting
& ImportingInvesting
& Financing
4
Chapter Objectives
• To identify the main goal of the 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.
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Goal of the MNC
• The commonly accepted goal of an MNC is to maximize shareholder wealth.
• 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, but can vary with the management style of the MNC.
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Goal of the MNC
• Various forms of corporate control can reduce agency problems - stock compensation, threat of hostile takeover, monitoring by large shareholders.
• As MNC managers attempt to maximize their firm’s value, they may be confronted with various environmental, regulatory, or 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.”
Theories of International Business
• Product Cycle Theory
Firm creates product to accommodate local demand.
1Firm exports product to accommodate foreign demand.
2
Firm establishes foreign subsidiary to establish presence in foreign country and possibly to reduce costs.
3
Firm differentiates product from competitors and/or expands product line in foreign country.
4a
Firm’s foreign business declines as its competitive advantages are eliminated.
4bor
9
International Business Methods
• International Trade - a relatively conservative approach involving exporting and/or importing.
• Licensing - provision of technology in exchange for fees or some other benefits.
• Franchising - provision of a specialized sales or service strategy, support assistance, and possibly an initial investment in the franchise in exchange for periodic fees.
10
International Business Methods
• Joint Ventures - joint ownership and operation by two or more firms.
• Acquisitions of Existing Operations
• Establishing New Foreign Subsidiaries
Any method of increasing international business that requires a direct investment in foreign operations normally is referred to as a direct foreign investment (DFI).
International OpportunitiesCost-benefit Evaluation for
Purely Domestic Firms versus MNCs
Marginal Return on
Projects
Marginal Cost of Capital
Purely Domestic Firm
Purely Domestic Firm
MNC
MNC
Appropriate Size for Purely Domestic Firm
Appropriate Size for MNC
X YAsset Level of Firm
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International Opportunities
• Opportunities in Europe¤ Single European Act of 1987¤ Removal of the Berlin Wall in 1989¤ Single currency system in 1999
• Opportunities in Latin America¤ North American Free Trade Agreement
(NAFTA) of 1993¤ General Agreement on Tariffs and Trade
(GATT) accord
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International Opportunities
• Opportunities in Asia¤ Significant growth expected for China¤ Asian economic crisis in 1997-1998
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Exposure to International Risk
• Exposure to Exchange Rate Movements¤ exchange rate fluctuations affect cash
flows and foreign demand
• Exposure to Foreign Economies¤ economic conditions affect demand
• Exposure to Political Risk¤ political actions affect cash flows
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Overview of an MNC’s Cash Flows
Profile A: MNCs focused on International Trade
U.S. Businesses
Foreign Importers
U.S. Customers
Foreign Exporters
U.S.-based MNC
$ for products
$ for supplies
$ for exports
$ for imports
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Overview of an MNC’s Cash Flows
Profile B: MNCs focused on International Trade and International Arrangements
U.S. Businesses
Foreign Importers
U.S. Customers
Foreign Exporters
Foreign Firms
U.S.-based MNC
$ for products
$ for supplies
$ for exports
$ for imports
$ for service
cost of service
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Overview of an MNC’s Cash Flows
Profile C: MNCs focused on International Trade, International Arrangements, and Direct Foreign Investment
U.S. Businesses
Foreign Importers
U.S. Customers
Foreign Exporters
Foreign Firms
Foreign Subsidiaries
U.S.-based MNC
$ for products
$ for supplies
$ for exports
$ for imports
$ for service
cost of service
funds remitted
funds invested
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Valuation Model for an MNC
• Domestic Model
Value = E CF$,
=
tt
t
n
k11
where E (CF$,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
Valuation Model for an MNC
• Valuing International Cash Flows
Value =
E CF E ER, ,
=
j t j tj
m
tt
n
k
1
1 1
where 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
Impact of New International Opportunities on an MNC’s Value
Value =
E CF E ER, ,
=
j t j tj
m
tt
n
k
1
1 1
More Exposure to Exchange Rate Risk
New International Opportunities
More Exposure to Political Risk
More Exposure to Foreign Economies
How Chapters Relate to Valuation
Background on
International Financial Markets
(Chapters 2-5)
Exchange Rate Behavior
(Chapters 6-8)
Long-Term Investment and
Financing Decisions
(Chapters 13-18)
Short-Term Investment and
Financing Decisions
(Chapters 19-21)
Exchange Rate Risk Management
(Chapters 9-12)
Risk and Return of
MNC
Value and Stock Price
of MNC
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Chapter Review
• Goal of the MNC¤ Conflicts against the MNC Goal¤ Impact of MNC’s Management Style on
Agency Costs¤ Impact of Corporate Control on Agency
Costs¤ Constraints Interfering with the MNC’s Goal
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Chapter Review
• Theories of International Business¤ Theory of Comparative Advantage¤ Imperfect Markets Theory¤ Product Cycle Theory
• International Business Methods¤ International Trade ¤ Licensing¤ Franchising ¤ Joint Ventures¤ Acquisitions of Existing Operations¤ Establishing New Foreign Subsidiaries
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Chapter Review
• International Opportunities¤ Opportunities in Europe¤ Opportunities in Latin America¤ Opportunities in Asia
• Exposure to International Risk¤ Exposure to Exchange Rate Movements¤ Exposure to Foreign Economies¤ Exposure to Political Risk