question

What is the goal of a financial manager?

answer

To maximize shareholder wealth, the value of the firm, and stock price.

question

MNC

answer

Multi National Corporation

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Common Finance Decisions

answer

1) Whether to discontinue operations in a particular country 2) Whether to pursue new business in a particular country 3) Whether to expand business in a particular country 4) How to finance expansion into a particular country

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What other business disciplines influence finance?

answer

Marketing, Management, Accounting and MIS

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Agency Problem

answer

The conflict of goals between managers and shareholders

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Agency Costs

answer

Cost of ensuring that managers maximize shareholder wealth

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Who has highest agency costs?

answer

MNC over domestic firms

question

Why do MNC have high agency problem?

answer

1) Monitoring managers of distant subsidiaries in foreign countries is more difficult. 2) Foreign subsidiary managers raised in different cultures may not follow uniform goals 3) Sheer size of larger MNCs can create large agency problem. 4) Some non-US managers tend to downplay the short-term effects of decisions. THEY ONLY CARE ABOUT THAT SUBSIDIARY

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Parent Control of Agency Problem

answer

Parent should clearly communicate the goals for each subsidiary to ensure managers focus on MAXIMIZING THE VALUE OF THE MNC, not their individual subsidiary. Common incentive: provide managers with MNC stock

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Corporate Control Agency Problem

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Entire management of the MNC must be focused on maximizing shareholder wealth. REDIRECT CORPORATE STRATEGY TO MOTIVATE MANAGERS TO WORK TOWARD THE FIRM'S GOAL, NOT JUST THE SUBSIDIARY.

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Sarbanes-Oxley Act (SOX)

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Ensures a more transparent process for managers to report on the productivity and financial condition of their firm. MAKES SURE FINANCIAL REPORTING BY MANAGERS IS ACCURATE

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How did SOX improve corporate governance of MNCs?

answer

1) Establish centralized database of information 2) Ensuring all data are reported consistently among subsidiaries 3) Implementing a system that automatically checks for unusual discrepancies relative to norms 4) Speeding up process to get departments and subsidiaries access to data they need 5) Make executives more accountable for financial statements

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Centralized Management Structure

answer

Financial manager of PARENT controls all decisions made about subsidiaries ADVANTAGE: Lower agency problem DISADVANTAGE: Worse decision making (parent is far away)

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Decentralized Management Structure

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Gives more control to SUBSIDIARY managers. ADVANTAGE: Better decision making. (Subsidiary manager is physically there) DISADVANTAGE: High agency problem. DECENTRALIZED - HIGH AGENCY PROBLEM

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Internet Facilities Management Control

answer

Easier for parent to monitor the actions and performance of its foreign subsidiaries.

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What are the 3 theories that justify why firm's pursue international business?

answer

1) Theory of Competitive Advantage 2) Imperfect Markets Theory 3) Product Cycle Theory

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Theory of Competitive Advantage

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SPECIALIZATION increases production efficiency. Country should produce what they specialize in. Rely on int'l trade for other goods and services. Certain countries have competitive advantage in certain areas.

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Imperfect Markets Theory

answer

Factors of production are somewhat immobile providing incentive to seek out foreign opportunities. Markets are imperfect and things like intelligence can't be easily transferred to other markets. IMPERFECT MARKETS give us a COMPETITIVE ADVANTAGE (tied together)

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Product Cycle Theory

answer

As a firm matures, it recognizes opportunities outside its domestic market As a FIRM EXPANDS it penetrates FOREIGN COUNTRIES AND MARKETS.

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How Firm's Engage in International Business

answer

1) International Trade 2) Licensing 3) Franchising 4) Joint Ventures 5) Acquisitions of Existing Operations 6) Establishing New Foreign Subsidiaries

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International Trade

answer

CONSERVATIVE APPROACH. IMPORTS/EXPORTS Imports - Obtain supplies at low cost Exports - Penetrate market NO CAPITAL INVESTMENT

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Licensing

answer

Obligates a firm to provide technology (ex. copyright, patent, trademark, trade name) in exchange for fees or other specified benefits. Give rights to a foreign firm to use your brand. Advantage: No major investment by US firm and no transportation costs that would come from exporting. Disadvantage: Difficult to ensure quality control. NO CAPITAL INVESTMENT BY US FIRM

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Franchising

answer

Obligates a firm to provide a specialized sales or service strategy, support assistance, and possibly initial investment in franchise in exchange for periodic fees Advantage: Allows penetration in foreign markets w/o investment in foreign countries. US company still has control of franchise CAPITAL INVESTMENT BY US FIRM

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Joint Ventures

answer

A venture jointly owned and operated by two or more firms. A firm can enter a foreign market by forming a joint venture with a firm already in that market. Advantage: allows two firms to apply their respective cooperative advantages in a given project. BOTH US AND FOREIGN INVESTMENT

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Acquisition of Existing Operations

answer

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. Disadvantage: Could have large losses b/c of large investment. LIqUIDATION MAY BE DIFFICULT if foreign subsidiary performs poorly. LOTS OF US INVESTMENT (MOST OF ANY OPTION)

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Establishing New Foreign Subsidiary

answer

Firms can penetrate market by establishing new operations in foreign countries. Disadvantage: requires a lot of investment. Advantage: Acquiring new instead of buying existing allows operations to be tailored to exactly what the firm needs. May be smaller investment than acquisition of existing firm. LOTS OF US FIRM INVESTMENT, BUT LESS THAN ACQUISITION OF EXISTING OPERATIONS

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DFI

answer

Direct Foreign Investment

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Methods with no DFI

answer

International Trade Licencing

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Methods with the most DFI

answer

Foreign acquisition Establishment of a new foreign subsidiary

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Valuation Model for MNC

answer

E(CF) = sum[E(CFforeign)*E(S exchange rate)]

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Uncertainty Surrounding MNC Cash Flows

answer

1) Exposure to international economic conditions 2) Exposure to international political risk 3) Exposure to exchange rate risk

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Exposure to International Economic Conditions

answer

If economic conditions in a foreign country get weaker, people buy less of that firm's products so MNC sales will be lower. IF FOREIGN ECONOMY GETS WORSE, THEN THE SUBSIDIARY WILL LOSE MONEY

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Exposure to international political risk

answer

A foreign government may increase taxes or impose barriers on the MNC's subsidiary.

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Exposure to Exchange Rate Risk

answer

If foreign currencies related to the MNC subsidiary weaken against the US dollar, the MNC will receive a lower amount of dollar cash flows then was expected. IF FOREIGN CURRENCY APPRECIATES THEN THE MNCs MONEY WILL INCREASE. BIGGEST RISK

question

Which models of foreign investment have exchange rate risk?

answer

ALL OF THEM. How to manage exposure: International trade: You can make short term decisions so you have less exposure New Subsidiary: US wants foreign currency to appreciate in the short term and depreciate in the long term.

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How Uncertainty Affects MNC's Cost of Capital

answer

HIGH level of uncertainty INCREASES the return on investment required by investors and the MNC's valuation DECREASES.

International Financial Management Ch. 1 – Flashcards

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