Part I

The International Financial Environment

Multinational Corporation (MNC)

Foreign Exchange Markets

Dividend
Remittance
Exporting & Financing Investing
& Importing & Financing

International
Product Markets Subsidiaries Financial Markets

For use with International Financial Management, 3e

Jeff Madura and Roland Fox 9781408079812
© Cengage Learning EMEA 2014
 Chapter 1
Multinational Financial
Management: An Overview

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Jeff Madura and Roland Fox 9781408079812
© Cengage Learning EMEA 2014
 Chapter Objectives
• To identify the main goal of the
multinational corporation (MNC) and
potential 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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Jeff Madura and Roland Fox 9781408079812
© Cengage Learning EMEA 2014
 Goal of the MNC
• The commonly accepted goal of an MNC is to maximize
shareholder wealth.
• We will focus on MNCs that wholly own their foreign
subsidiaries.
• Financial managers throughout the MNC have a single
goal of maximizing the value of the entire MNC.

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Jeff Madura and Roland Fox 9781408079812
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 Conflicts with the MNC Goal
• When a corporation’s shareholders differ
from its managers, a conflict of goals can
exist—the agency problem.
• Agency costs are normally larger for MNCs
than for purely domestic firms, due to:
– the difficulty in monitoring distant managers
– the different cultures of foreign managers
– the huge size of the larger MNCs, and
– the tendency to downplay short-term effects.

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 Impact of Management Control
• Subsidiary managers may be tempted to make
decisions that maximize the values of their
respective subsidiaries.
• 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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Jeff Madura and Roland Fox 9781408079812
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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
 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
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 parent’s management
monitors the decisions.
• Today, electronic networks make it easier
for the parent to monitor the actions and
performance of its foreign subsidiaries.

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Jeff Madura and Roland Fox 9781408079812
© Cengage Learning EMEA 2014
 Impact of Corporate Control
• Various forms of corporate control can
reduce agency costs:
– stock options
– hostile takeover threat
– investor monitoring

For use with International Financial Management, 3e

Jeff Madura and Roland Fox 9781408079812
© Cengage Learning EMEA 2014
 Constraints Interfering with the
MNC’s Goal
• MNC managers are confronted with various
constraints:
– environmental constraints
– regulatory constraints
– ethical constraints
• A recent study found that investors assigned a
higher value to firms that exhibit high corporate
governance standards and are likely to obey
ethical constraints.

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Jeff Madura and Roland Fox 9781408079812
© Cengage Learning EMEA 2014
 Theories of International
Business (1)
Does international business increase or decrease a
nation’s wealth?
1. Theory of Absolute Advantage
- Specializing in services and products that a country is
better at producing than other trading countries.
2. Theory of Comparative Advantage
– Specializing in services and products that countries are
less inefficient at producing than other countries. If
country A is worse than B in everything it may still be
beneficial for country A to specialize in its less inefficient
goods and services, and for country B to specialize in its
more efficient goods and services.
 Theories of International
Business (1)
Does international business increase or decrease a
nation’s wealth?

3. Imperfect Markets Theory

• Factors of production, mainly labor and physical
capital, cannot easily be transferred between
countries.
• Cheap labor in the East; advanced technology in the
West – these locational differences resolved through
trade of output.

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Jeff Madura and Roland Fox 9781408079812
© Cengage Learning EMEA 2014
 Theories of International
Business (2)
Why are firms motivated to expand their
business internationally?
4. Product Cycle Theory
– As a firm matures, it may recognize additional
opportunities outside its home country.
– The pattern of beneficial trade depends on the product
life cycle.

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Jeff Madura and Roland Fox 9781408079812
© Cengage Learning EMEA 2014
 The International Product Life Cycle

1. Firm creates 2. Firm exports

product to product to 3. Firm
accommodate accommodate establishes
local demand foreign demand foreign
subsidiary to
establish
presence in
4a. Firm foreign
or country and
differentiates
product from 4b. Firm’s possibly to
competitors foreign reduce costs
and/or expands business
product line in declines as its
foreign country competitive
advantages are
eliminated

For use with International Financial Management, 3e

Jeff Madura and Roland Fox 9781408079812
© Cengage Learning EMEA 2014
The International Product Life Cycle

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Jeff Madura and Roland Fox 9781408079812
© Cengage Learning EMEA 2014
 International Business
Methods
1. International trade involves exporting and/or
importing.
2. Licensing allows a firm to provide its technology in
exchange for fees or some other benefits.
3. Franchising obligates a firm to provide a
specialized sales or service strategy, support
assistance and possibly an initial investment, in
exchange for periodic fees.

For use with International Financial Management, 3e

Jeff Madura and Roland Fox 9781408079812
© Cengage Learning EMEA 2014
 International Business
Methods
4. Firms may also penetrate foreign markets by engaging
in a joint venture (joint ownership and operation) with
firms that reside in those markets.
5. 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.
6. Firms can also penetrate foreign markets by
establishing new foreign subsidiaries.

For use with International Financial Management, 3e

Jeff Madura and Roland Fox 9781408079812
© Cengage Learning EMEA 2014
 International Trade
• Relatively conservative approach that can be
used by firms to
– penetrate markets (by exporting)
– obtain supplies at a low cost (by importing).
• Minimal risk – no capital at risk
• The internet facilitates international trade by
allowing firms to advertise their products and
accept orders on their websites.

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Jeff Madura and Roland Fox 9781408079812
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 Licensing
• Obligates a firm to provide its technology
(copyrights, patents, trademarks, or trade
names) in exchange for fees or some other
specified benefits.
• Allows firms to use their technology in foreign
markets without a major investment and
without transportation costs that result from
exporting
• Major disadvantage: difficult to ensure quality
control in foreign production process
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Jeff Madura and Roland Fox 9781408079812
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 Franchising
• Obligates firm to provide a specialized sales
or service strategy, support assistance, and
possibly an initial investment in the franchise
in exchange for periodic fees.
• Allows penetration into foreign markets
without a major investment in foreign
countries.

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Jeff Madura and Roland Fox 9781408079812
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 Joint Ventures
• A venture that is jointly owned and operated
by two or more firms. A firm may enter the
foreign market by engaging in a joint venture
with firms that reside in those markets.
• Allows two firms to apply their respective
cooperative advantages in a given project.

For use with International Financial Management, 3e

Jeff Madura and Roland Fox 9781408079812
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 Acquisitions of Existing Operations

• Acquisitions of firms in foreign countries

allows firms to have full control over their
foreign businesses and to quickly obtain a
large portion of foreign market share.
• Subject to the risk of large losses because of
larger investment.
• Liquidation may be difficult if the foreign
subsidiary performs poorly.

For use with International Financial Management, 3e

Jeff Madura and Roland Fox 9781408079812
23 © Cengage Learning EMEA 2014
 Establishing New Foreign
Subsidiaries
• Firms can penetrate markets by establishing
new operations in foreign countries.
• Requires a large investment
• Acquiring new as opposed to buying existing
allows operations to be tailored exactly to the
firms needs.
• May require smaller investment than buying
existing firm.
For use with International Financial Management, 3e
Jeff Madura and Roland Fox 9781408079812
24 © Cengage Learning EMEA 2014
 Summary of Methods
• Many MNCs use a combination of methods
to increase international business.
• In general, any method of conducting
business that requires investment in more
than 10% of foreign operations is referred
to as a direct foreign investment (DFI).
Below 10% it is referred to as portfolio
investment.

For use with International Financial Management, 3e

Jeff Madura and Roland Fox 9781408079812
© Cengage Learning EMEA 2014
 Summary of Methods
• International trade and licensing usually not
included
• Foreign acquisition and establishment of new
foreign subsidiaries represent the largest
portion of DFI.

For use with International Financial Management, 3e

Jeff Madura and Roland Fox 9781408079812
26 © Cengage Learning EMEA 2014
 Exposure to International Risk
• International business usually increases
an MNC’s exposure to:
1. exchange rate movements
2. foreign economies
3. political risk

For use with International Financial Management, 3e

Jeff Madura and Roland Fox 9781408079812
© Cengage Learning EMEA 2014
 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
For use with International Financial Management, 3e
Jeff Madura and Roland Fox 9781408079812
© Cengage Learning EMEA 2014
Valuation Model for an MNC
• Valuing International Cash Flows
m 
n 
E CFj , 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.K. 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 MNC
adjusted for the risk of the particular investment.
For use with International Financial Management, 3e
Jeff Madura and Roland Fox 9781408079812
© Cengage Learning EMEA 2014