Solution Manual for International Financial Management, 13th Edition

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Chapter 1Multinational Financial Management: An OverviewLecture OutlineManagingthe MNCHow Business Disciplines Are Used to Manage the MNCAgency ProblemsManagement Structure of an MNCWhyFirmsPursueInternational BusinessTheory of Comparative AdvantageImperfect Markets TheoryProduct Cycle TheoryMethods to ConductInternational BusinessInternational TradeLicensingFranchisingJoint VenturesAcquisitions of Existing OperationsEstablishing New Foreign SubsidiariesSummary of MethodsValuation Model for an MNCDomestic ModelMultinational ModelUncertainty Surrounding an MNC’s Cash FlowsSummary of International EffectsHowUncertaintyAffects theMNC’s Cost of CapitalOrganization of the Text

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Multinational Financial Management:An Overview2Chapter ThemeThis chapter introduces the multinational corporation as having similar goals to the purely domesticcorporation, but a wider variety of opportunities. With additional opportunities come potential increasedreturns and other forms of risk to consider. The potential benefits and risks are introduced.Topics to Stimulate Class Discussion1.What is the appropriate definition of an MNC?2.Why does an MNC expand internationally?3.What are the risks of an MNC which expands internationally?4.Why must purely domestic firms be concerned about the international environment?POINT/COUNTER-POINT:Should an MNC Reduce Its Ethical Standards to Compete Internationally?POINT: Yes. When a U.S.-based MNC competes in some countries, it may encounter some businessnorms there that are not allowed in the U.S. For example, when competing for a government contract,firms might provide payoffs to the government officials who will make the decision. Yet, in the UnitedStates, a firm will sometimes take a client on an expensive golf outing or provide skybox tickets toevents. This is no different than a payoff. If the payoffs are bigger in some foreign countries, the MNCcan compete only by matching the payoffs provided by its competitors.COUNTER-POINT: No. A U.S.-based MNC should maintain a standard code of ethics that applies toany country, even if it is at a disadvantage in a foreign country that allows activities that might be viewedas unethical. In this way, the MNC establishes more credibility worldwide.WHO IS CORRECT? Use the Internetto learn more about this issue. Which argument do you support?Offer your own opinion on this issue.ANSWER: The issue is frequently discussed. It is easy to suggest that the MNC should maintain astandard code of ethics, but in reality, that means that it will not be able to compete in some cases. Forexample, even if it submits the lowest bid on a specific foreign government project, it will not receive thebid without a payoff to the foreign government officials. The issue is especially a concern for largeprojects that may generate substantial cash flows for the firm that is chosen to do the project. Ideally, theMNC can clearly demonstrate to whoever oversees the decision process that it deserves to be selected. Ifthere is just one decision-maker with no oversight, an MNC can not ensure that the decision will beethical. But if the decision-maker must be accountable to a department who oversees the decision, theMNC may be able to prompt the department to ensure that the process is ethical.

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Multinational Financial Management:An Overview3Answers to End of Chapter Questions1.Agency Problems of MNCs.a.Explain the agency problem of MNCs.ANSWER: The agency problem reflects a conflict of interests between decision-making managersand the owners of the MNC. Agency costs occur in an effort to assure that managers act in the bestinterest of the owners.b.Why might agency costs be larger for an MNC than for a purely domestic firm?ANSWER: The agency costs are normally larger for MNCs than purely domestic firms for thefollowing reasons. First, MNCs incur larger agency costs in monitoring managers of distant foreignsubsidiaries. Second, foreign subsidiary managers raised in different cultures may not follow uniformgoals, and some managers may focus on satisfying respective employees. Third, the sheer size of thelarger MNCs would also create large agency problems.2.Comparative Advantage.a.Explain how the theory of comparative advantage relates to the need for international business.ANSWER: The theory of comparative advantage implies that countries should specialize inproduction, thereby relying on other countries for some products. Consequently, there is a need forinternational business.b.Explain how the product cycle theory relates to the growth of an MNC.ANSWER: The product cycle theory suggests that at some point in time, the firm will attempt tocapitalize on its perceived advantages in markets other than where it was initially established.3.Imperfect Markets.a.Explain how the existence of imperfect markets has led to the establishment of subsidiaries inforeign markets.ANSWER:Because of imperfect markets, resources cannot be easily and freely retrieved by theMNC. Consequently, the MNC must sometimes go to the resources rather than retrieve resources(such as land, labor, etc.).b.Suppose perfect markets existed.WouldIf perfect markets existed, would wages, prices, andinterest rates among countries be more similar or less similar than under conditions of imperfectmarkets? Why?ANSWER: If perfect markets existed, resources would be more mobile and could therefore betransferred to those countries more willing to pay a high price for them. As this occurred, shortagesof resources in any particular country would be alleviated and the costs of such resources would besimilar across countries.

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Multinational Financial Management:An Overview44.International Opportunities.a.Do you thinkthat eitherthe acquisition of a foreign firm or licensing will result in greater growthfor an MNC? Which alternative is likely to have more risk?ANSWER:An acquisition will typically result in greater growth, but it is more risky because itnormally requires a larger investment and the decision can not be easily reversed once the acquisitionis made.b.Describe a scenario in which the size of a corporation is not affected by access to internationalopportunities.ANSWER: Some firms may avoid opportunities because they lack knowledge about foreign marketsor expect that the risks are excessive. Thus, the size of these firms is not affected by theopportunities.c.Explain why MNCs such as Coca Cola and PepsiCo, Inc., still have numerous opportunities forinternational expansion.ANSWER: Coca Cola and PepsiCo still have new international opportunities because countries are atvarious stages of development. Some countries have just recently opened their borders to MNCs.Many of these countries do not offer sufficient food or drink products to their consumers.5.International Opportunities Due to the Internet.a.What factors cause some firms to become more internationalized than others?ANSWER: The operating characteristics of the firm (what it produces or sells) and the risk perceptionof international business will influence the degree to which a firm becomes internationalized.Severalother factors such as access to capital could also be relevant here. Firms that are labor-intensive couldmore easily capitalize on low-wage countries while firms that rely on technological advances could not.b.Offer your opinion on why the Internet may result in more international business.ANSWER: The Internet allows for easy and low-cost communication between countries, so that firmscould now develop contacts with potential customers overseas by having a website. Many firms usetheir website to identify the products that they sell, along with the prices for each product. Thisallows them to easily advertise their products to potential importers anywhere in the world withoutmailing brochures to various countries. In addition, they can add to their product line and changeprices by simply revising their website, so importers are kept abreast of the exporter’s productinformation by monitoring the exporter’s website periodically. Firms can also use their websites toaccept orders online.Some firms with an international reputation use their brand name to advertiseproducts over the internet. They may use manufacturers in some foreign countries to produce someof their products subject to their specification6.Impact of Exchange Rate Movements.Plak Co. of Chicago has several European subsidiaries thatremit earnings to it each year. Explain how appreciation of the euro (the currency used in manyEuropean countries) would affect Plak's valuation.ANSWER:Plak’s valuation should increase because the appreciation of the euro will increase thedollar value of the cash flows remitted by the European subsidiaries.

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Multinational Financial Management:An Overview57.Benefits and Risks of International Business.As an overall review of this chapter, identify possiblereasons for growth in international business. Then, list the various disadvantages that may discourageinternational business.ANSWER: Growth in international business can be stimulated by (1) access to foreign resourceswhich can reduce costs, or (2) access to foreign markets which boost revenues. Yet, internationalbusiness is subject to risks of exchange rate fluctuations,and political risk (such asapossiblehostgovernment takeover, tax regulations, etc.).8.Valuationof an MNC.Hudson Co., a U.S. firm, has a subsidiary in Mexico, where political risk hasrecently increased. Hudson's best guess of its future peso cash flows to be received has not changed.However, its valuation has declined as a result of the increase in political risk. Explain.ANSWER:The valuation of the MNC is the present value of expected cash flows. The increase inrisk results in a higher expected return, which reduces the present value of the expected future cashflows.9.Centralization and Agency Costs.Would the agency problem be more pronounced for BerkleyCorp., whoseparent company makesmost major decisions for its foreign subsidiaries, or OaklandCorp., which uses a decentralized approach?ANSWER: The agency problem would be more pronounced for Oakland because of a higherprobability that subsidiary decisions would conflict with the parent. Assuming that the parentattempts to maximize shareholder wealth, decisions by the parent should be compatible withshareholder objectives. If the subsidiaries made their own decisions, the agency costs would behigher since the parent would need to monitor the subsidiaries to assure that their decisions wereintended to maximize shareholder wealth.10.Global Competition.Explain why more standardized product specifications across countries canincrease global competition.ANSWER: Standardized product specifications allow firms to more easily expand their businessacross other countries, which increases global competition.11.Exposure to Exhange Rates.McCanna Corp., a U.S. firm,has a French subsidiary that produceswine and exports to various European countries.All of the countries where it sells its wine use theeuro as their currency, which is the same as the currency used in France. Is McCanna Corp. exposedto exchange rate risk?ANSWER:The subsidiary and its customers based in countries that now use the euro as theircurrency would no longer be exposed to exchange rate risk.However, McCanna Corp is exposed toexchange rate risk, because the subsidiary will ultimately remit its earnings to the parent, and the euroearnings will be converted to dollars when they are remitted.12.Macro versus Micro Topics.Review the table of contents and indicate whether each of the chaptersfrom Chapter 2 through Chapter 21 has a macro or micro perspective.ANSWER: Chapters 2 through 8 are macro, while Chapters 9 through 21 are micro.13.Methods Used to Conduct International Business.Duve, Inc., desires to penetrate a foreign marketwith either a licensing agreement with a foreign firm or by acquiring a foreign firm. Explain the

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Multinational Financial Management:An Overview6differences in potential risk and return between licensing with a foreign firm, and acquiringa foreignfirm.ANSWER: A licensing agreement has limited potential for return, because the foreign firm willreceive much of the benefits as a result of the licensing agreement. Yet, the MNC has limited risk,because it did not need to invest substantial funds in the foreign country.An acquisition by the MNC requires a substantial investment. If this investment is not a success, theMNC may have trouble selling the firm it acquired for a reasonable price. Thus, there is more risk.However, if this investment is successful, all of the benefits accrue to the MNC.14.International Business Methods.Snyder Golf Co., a U.S. firm that sells high-quality golf clubs inthe U.S., wants to expand internationally by selling the same golf clubs in Brazil.a.Describe the tradeoffs that are involved for each method (such as exporting, direct foreigninvestment, etc.) that Snyder could use to achieve its goal.ANSWER: Snyder can export the clubs, but the transportation expenses may be high. If couldestablish a subsidiary in Brazil to produce and sell the clubs, but this may require a large investmentof funds. It could use licensing, in which it specifies to a Brazilian firm how to produce the clubs. Inthis way, it does not have to establish its own subsidiary there.b.Which methodof international methodwould you recommend for this firm? Justify yourrecommendation.ANSWER: If the amount of golf clubs to be sold in Brazil is small, it may decide to export. However,if the expected sales level is high, it may benefit from licensing. If it is confident that the expectedsales level will remain high, it may be willing to establish a subsidiary. The wages are lower in Brazil,and the large investment needed to establish a subsidiary may be worthwhile.15.Impact of Political Risk.Explain why political risk may discourage international business.ANSWER: Political risk increases the rate of return required to invest in foreign projects. Someforeign projects would have been feasible if there was no political risk, but will not be feasiblebecause of political risk.16.Impact of9/11.Following the terrorist attack on the U.S., the valuations of many MNCs declined bymore than 10 percent. Explain why the expected cash flows of MNCs were reduced, even if they werenot directly hit by the attacks.ANSWER: An MNC’s cash flows could be reduced in the following ways. First, a decline in travelwould affect any MNCs that have business in travel-related industries. The airline, hotel, and tourist-related industries were expected to experience a decline in business. Layoffs were announcedimmediately by many of these MNCs. Second, these effects on travel-related industries can carry overto other industries, and weaken economies. Third, the cost of international trade increased as a resultof tighter restrictions on some products. Fourth, some MNCs incurred expenses as a result ofincreasing security to protect their employees.Advanced Questions

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Multinational Financial Management:An Overview717.International Joint Venture.Anheuser-Busch,(which is now part of AB InBev due to a merger),the producer of Budweiser and other beers, has engagedin a joint venture with Kirin Brewery, thelargest brewery in Japan. The joint venture enables Anheuser-Busch to have its beer distributedthrough Kirin’s distribution channels in Japan. In addition, it couldutilize Kirin’s facilities toproduce beer that wouldbe sold locally. Inreturn, Anheuser-Busch providedinformation about theAmerican beer market to Kirin.a.Explain how the joint ventureenabledAnheuser-Busch to achieve its objective of maximizingshareholder wealth.ANSWER: The joint venture creates a way for Anheuser-Busch to distribute Budweiser throughoutJapan. It enables Anheuser-Busch to penetrate the Japanese market without requiring a substantialinvestment in Japan.b.Explain how the joint venturelimitedthe risk of the international business.ANSWER: The joint venture has limited risk because Anheuser-Busch does not need to establish itsown distribution network in Japan. Thus, Anheuser-Busch may be able to use a smaller investmentfor the international business, and there is a higher probability that the international business will besuccessful.c.Many international joint ventures are intended to circumvent barriers that normally preventforeign competition. What barrier in Japan did Anheuser-Busch circumventas a result of thejoint venture? What barrier in the United StatesdidKirin circumvent as a result of the jointventure?ANSWER: Anheuser-Busch is able to benefit from Kirin’s distribution system in Japan, which wouldnot normally be so accessible. Kirin is able to learn more about how Anheuser-Busch expanded itsproduct across numerous countries, and therefore breaks through an “information” barrier.d.Explain how Anheuser-Busch could have lostsome of its market share in countries outside Japanas a result of this particular joint venture.ANSWER: Anheuser-Busch could lose some of its market share to Kirin as a result of explaining itsworldwide expansion strategies to Kirin. However, it appears that Anheuser-Busch expects thepotential benefits of the joint venture to outweigh any potential adverse effects.18.Impact of Eastern European Growth.The managers of Loyola Corp. recently had a meeting todiscuss new opportunities in Europe as a result of the recent integration among Eastern Europeancountries. They decided not to penetrate new markets because of their present focus on expandingmarket share in the United States. Loyola’s financial managers have developed forecasts for earningsbased on the 12 percent market share (defined here as its percentage of total European sales) thatLoyola currently has in Eastern Europe. Is 12 percent an appropriate estimate for next year’s EasternEuropean market share? If not, does it likely overestimate or underestimatenext year’sactual EasternEuropean market share next year?ANSWER: It would likely overestimate its market share because the competition should increase ascompetitors penetrate the European countries.19.Valuation of an MNC.Birm Co., based in Alabama,isconsideringseveral internationalopportunities in Europe that could affect the value of its firm. The valuation of its firm is dependenton four factors: (1) expected cash flows in dollars, (2) expected cash flows in euros that are ultimately

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Multinational Financial Management:An Overview8converted into dollars, (3) the rate at which it can convert euros to dollars, and (4) Birm’s weightedaverage cost of capital. For each opportunity, identify the factors that would be affected.a.Birm plans a licensing deal in which it will sell technology to a firm in Germany for $3,000,000;the payment is invoiced in dollars, and this project has the same risk level as its existingbusinesses.b.Birm plans to acquire a large firm in Portugal that is riskier than its existing businesses.c.Birm plans to discontinue its relationship with a U.S. supplier so that can import a small amountof supplies (denominated in euros) at a lower cost from a Belgian supplier.d.Birm plans to export a small amount of materials to Ireland that are denominated in euros.ANSWER:OpportunityDollar CFEuro CFExchange rate atwhich Birm Co.converts euros todollarsBirm’s weightedaverage cost ofcapitala. joint ventureXb. acquisitionXXc. imported suppliesXd. exports to IrelandX20.Assessing Motives for International Business.Fort Worth Inc. specializes in manufacturing somebasic parts for sports utility vehicles that are produced and sold in the U.S. Its main advantage in theU.S. is that its production is efficient, and less costly than that of some other unionizedmanufacturers. It has a substantial market share in the U.S. Its manufacturing process is labor-intensive.The companypays relatively low wages compared to U.S. competitors, butithasguaranteed the local workers that their positions will not be eliminated for the next 30 years. It hireda consultant to determine whether it should set up a subsidiary in Mexico, where the parts would beproduced. The consultant suggested that Forth Worth expand for the following reasons. Offer youropinion on whether the consultant’s reasons are logical:a.Theory of Competitive Advantage: There are not many SUVs sold in Mexico; hence,Fort WorthInc. would not face much competition there.b.Imperfect Markets Theory: Fort Worth Inc. can not easily transfer workers to Mexico, but it canestablish a subsidiary there in order to penetrate a new market.c.Product Cycle Theory: Fort Worth Inc. has been successful in the U.S. It has limited growthopportunities because it already controls much of the U.S. market for the parts it produces. Thus,the natural next step is to conduct the same business in a foreign country.d.Exchange Rate Risk. The exchange rate of the peso has weakened recently, so this would allowFort Worth Inc. to build a plant at a very low cost (by exchanging dollars for the cheap pesos tobuild the plant).

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Multinational Financial Management:An Overview9e.Political Risk. The political conditions in Mexico have stabilized in the last few months, so FortWorth should attempt to penetrate the Mexican market now.ANSWER: None of the arguments by the consultant are logical. If SUVs are not sold in the Mexicanmarket, there is no need for these parts in Mexico. Fort Worth Inc. should only attempt to penetrate anew market if there is demand. Just because it has limited growth potential in the U.S., this does notmean that there will be demand for its product in Mexico. Even if the exchange rate is low relative torecent periods, it could decline further, which would adversely affect any the dollar amount of futureremitted earnings. Stable political conditions in Mexico are not a sufficient reason to pursue directforeign investment there.21.Valuationof Walmart’s International BusinessIn addition to its stores in the United States,Walmart Stores, Inc. has 107 retail units in Argentina, 359 in Brazil, 395 in Canada, 412 in China,2,296 in Mexico, and 604 in the United Kingdom. Overall, it has 6,100 retail units in foreigncountries. Consider that the value of Walmart is composed of two parts, a U.S. part (due to businessin the United States) and a non-U.S. part (due to business in other countries). Explain how todetermine the present value (in dollars) of the non-U.S. part assuming that you had access to all thedetails of Walmart businesses outside the United States.ANSWER: The non-U.S. part can be measured as the present value of future dollar cash flowsresulting from the non-U.S. businesses. Based on recent earnings data for each store and applying anexpected growth rate, you can estimate the remitted earnings that will come from each country in eachyear in the future. You can convert those cash flows to dollars using a forecasted exchange rate peryear. Determine the present value of cash flows of all stores within one country. Then repeat theprocess for other countries. Then add up all the present values that you estimated to derive aconsolidated present value of all non-U.S. subsidiaries.22.Impact of International Business on Cash Flows and Risk.Nantucket Travel Agency specializesin tours for American tourists. Until recently, all of its business was in the U.S. It just established asubsidiary in Athens, Greece, which provides tour services in the Greek islands for American tourists.It rented a shop near the port of Athens. It also hired residents of Athens, who could speak Englishand provide tours of the Greek islands. The subsidiary’s main costs are rent and salaries for itsemployees and the lease of a few large boats in Athens that it uses for tours. American tourists pay forthe entire tour in dollars at Nantucket’s main U.S. office before they depart for Greece.a.Explain why Nantucket may be able to effectively capitalize on international opportunities suchas the Greek island tours.ANSWER: It already has established credibility with American tourists, but could penetrate a newmarket with some of the same customers that it has served on tours in the U.S.b.Nantucket is privately-owned by owners who reside in the U.S. and work in the main office.Explain possible agency problems associated with the creation of a subsidiary in Athens, Greece.How can Nantucket attempt to reduce these agency costs?ANSWER: The employees of the subsidiary in Athens are not owners, and may have no incentive to managein a manner that maximizes the wealth of the owners. Thus, they may manage the tours inefficiently.Nantucket could attempt to allow the employees a portion of the ownership of the company so thatthey benefit more directly from good performance. Alternatively, Nantucket may consider having oneof its owners transfer to Athens to oversee the subsidiary’s operations.

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Multinational Financial Management:An Overview10c.Greece’s cost of labor and rent are relatively low. Explain why this information is relevant toNantucket’s decision to establish a tour business in Greece.ANSWER: The low cost of rent and labor will be beneficial to Nantucket, because it enablesNantucket to create the subsidiary at a low cost.d.Explain how the cash flow situation of the Greek tour business exposes Nantucket to exchangerate risk. Is Nantucket favorably or unfavorably affected when the euro (Greece’s currency)appreciates against the dollar? Explain.ANSWER: Nantucket’s tour business in Greece results in dollar cash inflows and euro cash outflows.It will be adversely affected by the appreciation of the euro because it will require more dollars tocover the costs in Athens if the euro’s value rises.e.Nantucket plans to finance its Greek tour business. Its subsidiary could obtain loans in euros froma bank in Greece to cover its rent, and its main office could pay off the loans over time.Alternatively, its main office could borrow dollars and would periodically convert dollars to eurosto pay the expenses in Greece. Does either type of loan reduce the exposure of Nantucket toexchange rate risk? Explain.ANSWER: No. The euro loans would be used to cover euro expenses, but Nantucket would needdollars to pay off the loans. Alternatively, the U.S. dollar loans would still require conversion ofdollars to euros. With either type of loan, Nantucket is still adversely affected by the appreciation ofthe euro against the dollar.f.Explain how the Greek island tour business could expose Nantucket to country risk.ANSWER: The subsidiary could be subject to government restrictions or taxes in Greece that wouldplace it at a disadvantage relative to other Greek tour companies based in Athens.23.Valuation of an MNC.Yahoo! has expanded its business by establishing portals in numerouscountries, including Argentina, Australia, China, Germany, Ireland, Japan, and the U.K. It has cashoutflows associated with the creation and administration of each portal. It also generates cash inflowsfrom selling advertising space on its website. Each portal results in cash flows in a different currency.Thus, the valuation of Yahoo! is based on its expected future net cash flows in Argentine pesos afterconverting them into U.S. dollars, its expected net cash flows in Australian dollars after convertingthem into U.S. dollars, and so on. Explain how and why the valuation of Yahoo! would change ifmost investors suddenly expected that that the dollar would weaken against most currencies overtime.ANSWER:The valuation of Yahoo! should increase because the present value of expected dollarcash flows to be received would increase.24.Uncertainty Surrounding an MNC’s Valuation.Carlisle Co. is a U.S.firm that is about topurchasea large company in Switzerlandfor$20 million. This company produces furniture and sells it locally(in Switzerland), and it is expected to earn large profits every year. The company will become asubsidiary of Carlisle and will periodically remittheexcess cash flowsfromto its profits to CarlisleCo. Assume that Carlisle Co. has no other international business. Carlisle has $10 million that it willuseto pay for part of the Swiss company and will finance the rest of its purchase with borroweddollars. Carlisle Co. can obtain supplies from either a U.S. supplier or a Swiss supplier (in which casethe payment would be made in Swiss francs). Both suppliers are reputable and there would be no

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Multinational Financial Management:An Overview11exposure to country risk when usingonesupplier. Is the valuation of the total cash flows of CarlisleCo. more uncertain if it obtains its supplies from a U.S. firm or a Swiss firm? Explain briefly.ANSWER:The valuation of Carlisle Co. is more uncertain if it uses a U.S. supplier because it willhave a larger amount of cash flows that will be remitted from Switzerland and converted into dollars.If it obtains supplies from Switzerland, it can use a portion of its Swiss franc cash flows to cover thecost, and will convert a smaller amount of francs into dollars on a periodic basis. Thus, it is lessexposed when sourcing from Switzerland.25.Impact of Exchange Rates on MNC Value.Olmsted Co. has small computer chips assembled inPoland and transports the final assembled products to the parent, where they are sold by the parent inthe U.S. The assembled products are invoiced in dollars.It uses Polish currency (the zloty) to producethese chips, and assembles them in Poland. The Polish subsidiary pays the employees in the localcurrency (zloty). Olmsted Co. finances its subsidiary operations with loans from a Polish bank (inzloty). The parent of Olmsted will send sufficient monthly payments (in dollars) to the subsidiary inorder to repay the loan and other expenses incurred by the subsidiary. If the Polish zloty depreciatesagainst the dollar over time, will that have a favorable, unfavorable, or neutral effect on the value ofOlmsted Co.? Briefly explain.ANSWER:It will have a favorable effect because Olmsted incurs expenses in the zloty and it will beable to cover these expenses with fewer dollars if the zloty depreciates. It will also be able to repaythe zloty loan with fewer dollars if the zloty depreciates.26.Impact of Uncertainty on MNC Value.Minneapolis Co. is a major exporter of products toCanada.Today, an event occurred that has increased the uncertainty surrounding the Canadian dollar’s futurevalue over the long term. Explain how this event can affect the valuation of Minneapolis Co.ANSWER:The future dollar cash flows of Minneapolis Co. are now more uncertain, which canincrease its cost of capital (the denominator of the MNC valuation equation), and reduce its valuation.27.Exposure of MNCs to Exchange Rate Movements.Arlington Co. expects to receive 10 millioneuros in each of the next 10 years. It will need to obtain 2 million Mexican pesos in each of the next10 years. The euro is presently valued at $1.38 and is expected to depreciate by 2 percent each year.The peso is valued at $.13 and is expected to depreciate by 2 percent each year. Review the valuationequation for an MNC. Do you think that the exchange rate movements will have a favorable orunfavorable effect on the MNC?ANSWER:The movements in the euro are expected to have an unfavorable effect on Arlington’svalue. The expected movements in the peso are expected to have a favorable effect on Arlington’svalue. However, the expected peso effect should be smaller because the dollar amount of business inpesos is smaller. Thus, the overall effect should be unfavorable.28.Impact of a Recession on an MNC’s Value.If a U.S. recession occurred without any change ininterest rates, identify the part of the MNC valuation equation that would likely be most affected.ANSWER:The domestic cash flows would likely be reduced as a result of the U.S. recession, whichwould reduce the valuation of the MNC.29.Exposure of MNCs to Exchange Rate Movements.Because of the low labor costs in Thailand,Melnick Co. (based in the United States) recently established a major research and developmentsubsidiary there. Thewholly-ownedsubsidiary was created to improve new products that the parent

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Multinational Financial Management:An Overview12of Melnick can sell in the United States (denominated in dollars) to U.S. customers. The subsidiarypays its local employees in baht (the Thai currency). The subsidiary has a small amount of salesdenominated in baht, but its expenses are much larger than its revenue. It has just obtained a largebaht-denominatedloanthat will be used to expand its subsidiary. The business that the parent ofMelnick Co. conducts in the United States is not exposed to exchange rate risk. If the Thai bahtweakens over the next 3 years, will the value of Melnick Co. be favorably affected, unfavorablyaffected, orunaffected? Briefly explain.ANSWER:It will be favorably affected since it needs fewer dollars over time to cover its loanpayments and its baht expenses. Its revenueismostly in dollars and therefore will not be significantlyaffected by a depreciation of the baht.30.Shareholder Rights of Investors in MNCs.MNCs tend to expand more when they more easilyaccess funds by issuing stock. In some countries, shareholder rights are very limited andsothe MNCsare less ableto raise funds by issuing stock. Explain why access to funding is more severe for MNCsbased in countries where shareholder rights are limited.ANSWER:Shareholders may be concerned that the agency problems of the local firms would be verysevere, if there are no laws that grant shareholders rights. They will only purchase stock if they haverights that can help them force managers of local firms to serve shareholder interests. Local investorscan invest their money in other countries where there are shareholder rights.31.MNC Cash Flows and Exchange Rate Risk.TuscaloosaCo. is a U.S. firm that assembles phones inArgentina and transports the final assembled products to the parent,which sells themin the U.S.. Theassembled products are invoiced in dollars. The Argentine subsidiary obtains some material fromChina, and the Chinese exporter is willing to accept Argentine pesos as payment for theseexportedmaterials. The Argentine subsidiary pays its employees in the local currency (pesos), and finances itsoperations with loans from an Argentine bank (in pesos). Tuscaloosa Co. has no other internationalbusiness.If the Argentine peso depreciates against the dollar over time, will that have a favorable,unfavorable, or neutral effect on Tuscaloosa Co.? Briefly explain.Tuscaloosa Co. has no cash inflows in Argentine pesos, but has cash outflows in Argentine pesos.Therefore, it benefits if the peso depreciates because it can obtain pesos with fewer dollars and canreduce its cost.32.MNC Cash Flows and Exchange Rate Risk.Asheville Co. has a subsidiary in Mexico thatdevelops software for its parent. It rents a large facility in Mexico and hires many people in Mexico towork in the facility. Ashville Co. has no other international business. All operations are presentlyfunded by Asheville’s parent. All the software is sold to U.S. firms by Asheville’s parent andisinvoiced in U.S. dollars.a.If the Mexican peso appreciates against the dollar, does this have a favorable effect,anunfavorable effect, or no effect on Asheville’s value?b.Asheville Co. plans to borrow funds to support its expansion in the U.S. The Mexican interestrates are presently lower than U.S. interest rates, so Asheville obtains a loan denominated inMexican pesos in order to support its expansion in the U.S. Will the borrowing of pesos increase,decrease, or have no effect on its exposure to exchange rate risk? Briefly explain.ANSWER:

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Multinational Financial Management:An Overview13a.Appreciation of the peso has an unfavorable effect because it results in higher dollar expenses toAsheville Co.b.Borrowing pesos will increase Asheville's exposure because it will increase the amount of dollarcash outflows that are needed to cover expenses.33.Estimating an MNC's Cash Flows.Biloxi Co. is a U.S. firmwitha subsidiary in China. Thesubsidiary reinvests half of its net cash flows into operations and remits half to the parent. Biloxi Co.has expected cash flowsof$10,000,000from domestic businessand the Chinese subsidiary isexpected to generate 100 million Chinese yuan at the end of the year. The expected value of yuan atthe end of the year is $.13. What are the expected dollar cash flows of the parent of Biloxi Co. in oneyear?ANSWER:[$10,000,000 + 100,000,000]/2[$.13] = 16,500,000.34.Uncertainty Surrounding an MNC's Cash Flows.a.Assume that Bangor Co. (a U.S. firm) knows that it will have cash inflows of $900,000 fromdomestic operations, cash inflows of 200,000 Swiss francsresulting fromexports to Swissoperations, andcash outflows of 500,000 Swiss francs at the end of the year.Althoughthe futurevalue of the Swiss franc isuncertain, your best guess is thatitwill beworth$1.10 at the endofthis year. What are the expected dollar cash flows of Bangor Co?b.Assume thatConcord Co. (a U.S. firm) is in the same industry as Bangor Co. There is no politicalrisk that could have any impact on the cash flows of eitherfirm. Concord Co. knowsthat it willhave cash inflows of $900,000 from domestic operations, cash inflows of 700,000 Swiss francsfromexports to Swiss operations, and cash outflows of 800,000 Swiss francs at the end of theyear.Is the valuation of the total cash flows of Concord Co. more uncertain or less uncertain thanthe total cash flows of Bangor Co.? Explain briefly.ANSWER:a.$900,000 + (-$300,000 x $1.10) = $570,000b.The cash flows of Bangor are more uncertain because a larger proportion of the cash flows aresubject to exchange rate risk.35.Valuation of an MNC.Odessa Co., Midland Co., and Roswell Co. are U.S. firms in the same industryand have the same valuation as of yesterday, based on the present value of future cash flows of eachcompany. Odessa Co. obtains a large amount of its supplies invoiced in euros from European countries,and all of its sales are invoiced in dollars. Midland has a large subsidiary in Europe that does all of itsbusiness in euros and remits profits to the U.S. parent every year. Roswell Co. has no internationalbusiness.Suppose an event occursthat you believe will cause a substantial depreciation of the euroagainst the dollar over time, but assumethis event will not change the business operations of thefirmsmentioned. Which firm will have the highest valuation based on your expectations? Briefly explain.ANSWEROdessa Co. will have the highest valuation because it benefits from the expected depreciation overtime. Midland would be adversely affected by the euro's depreciation.

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Solution Manual for International Financial Management, 13th Edition - Page 15 preview image

Multinational Financial Management:An Overview1436.Impact of Uncertainty on an MNC's Valuation.Assume that Alpine Co. is a U.S. firm that hasdirect foreign investment in Brazil as a result establishing a subsidiary there. Political conditions havechanged in Brazil, but the best guess byinvestors regarding the future annual cash flows for AlpineCo. has not changed despite the uncertainty surrounding those estimates. In other words, thedistribution of possible outcomes above and below the best guess has widened. Would this changeinuncertainty cause the prevailing value of Alpine Co. to increase, decrease, or remain unchanged?Briefly explain.ANSWER:The increase in uncertainty surrounding cash flows would cause the prevailing value ofAlpine Co. to decrease, because the required rate of return by investors would increase. Thus, thenumerator of the valuation of Alpine Co. has not changed, but the denominator has increased,resulting in a lower valuation.37.Exposure of MNC Cash Flows.a.Rochester Co. is a U.S. firm that has a language institute in France. This institute attractsAmericans who want to learn the French language. Rochester Co. charges tuition to the Americanstudents in dollars. It expects that its dollar revenue from charging tuition will be stable over eachof the next several years.Rochester’stotal expenses for thisbusinessproject are as follows. Itrents a facility in Paris, and makes a large rent payment each month in euros. It also hires severalFrench citizens as full-time instructors, and pays their salary in euros. Rochester Co.expects thatitseuro-denominatedexpenses will be stable over each of the next several years. If the euroappreciates against the dollar over time, shouldthis have a favorable effect, unfavorable effect, orno effect on the value of Rochester Co.? Briefly explain.ANSWER:It should have an unfavorable effect, because it will take more dollars to cover the euroexpenses over time. Thus, the net cash flows in dollars generated by Rochester should decrease over time.b.Rochester considers a new project in which it would also attract people from Spain, and theinstitute in France would teach them the Frenchlanguage; tuition would be charged in euros. Theexpenses for this project would be about the same as those for the one just described forAmerican students.Assume that euros to be generated by this project would be stable over thenext several years. Assume that this project is about the same size as the project for Americanstudents. For either project, the expected annual revenue is just slightly larger than the expectedannual expenses. Is the valuation of net cash flows subject to a higher degree of exchange raterisk for this project or for the project for American students? Briefly explain.ANSWER:The valuation of net cash flows for the project focused on American students is moreuncertain, because the invoice currency and currency denominating expenses are different. Theproject for students in Spain uses the same currency (euros) to generate revenue as the currency that itneeds to cover expenses.CRITICAL THINKINGImpact of International Environment of MNC Cash FlowsConduct an online search to review arecent annual report of the operations of any publicly-traded U.S.-based MNC. Write a brief essay inwhich you describe how the MNC’s cash flows are exposed to the international environment. Is the MNCyou selected most exposed to a particular currency? If so, how would depreciation of that currencyagainst the dollar affect the value of the MNC? Is the MNC exposed to economic conditions in aparticular foreign country? If so, describe how a change in the conditions of that country could adverselyaffect the MNC’s cash flows.ANSWER

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Multinational Financial Management:An Overview15This essay is intended to allow students to learn from their own application how the MNC’s valuation andcash flows could be adversely affected by its exposure to one or more foreign currencies and countryeconomies.Solution to Continuing Case Problem: Blades, Inc.1.What are the advantages Blades could gain from importing from and/or exporting to a foreign countrysuch as Thailand?ANSWER: The advantages Blades, Inc. could gain from importing from Thailand include potentiallylowering Blades’ cost of goods sold. If the inputs (rubber and plastic) are cheaper when importedfrom a foreign country such as Thailand, this would increase Blades’ net income. Since numerouscompetitors of Blades are already importing components from Thailand, importing would increaseBlades’ competitiveness in the U.S., especially since its prices are among the highest in the rollerblade industry. Furthermore, since Blades is considering longer range plans in Thailand, importingfrom and exporting toThailand may present it with an opportunity to establish initial relationshipswith some Thai suppliers. As far as exporting is concerned, Blades, Inc. could be one of the first firmsto sell roller blades in Thailand. Considering that Blades is contemplating to eventually shift its salesto Thailand, this could be a major competitive advantage.2.What are some of the disadvantages Blades could face as a result of foreign trade in the short run? Inthe long run?ANSWER: There are several potential disadvantages Blades, Inc. should consider. First of all, Bladeswould be exposed to currency fluctuations in the Thai baht. For example, the dollar cost of importedinputs may become more expensive over time if the baht appreciates even if Thai suppliers do notadjust their prices. However, Blades’ sales in Thailand would also increase in dollar terms if the bahtappreciates, even if Blades does not increase its prices. Blades, Inc. would also be exposed to theeconomic conditions in Thailand. For example, if there is a recession, Blades would suffer fromdecreased sales to Thailand.In the long run, Blades should be aware of any regulatory and environmental constraints the Thaigovernment may impose on it (such as pollution controls). Furthermore, the company should beaware of the political risk involved in operating in Thailand. For example, the likelihood ofexpropriation by the Thai government should be assessed. Another important issue involved inBlades’ long-run plans is how the foreign subsidiary would be monitored. Geographical distance maymake monitoring very difficult. This is an especially important point since Thai managers mayconform to goals other than the maximization of shareholder wealth.3.Which theories of international business described in this chapter apply to Blades, Inc. in the shortrun? In the long run?ANSWER: There are at least three theories of international business: the theory of comparativeadvantage, the imperfect markets theory, and the product cycle theory. In the short run, Blades wouldlike to import from Thailand because inputs such as rubber and plastic are cheaper in Thailand. Also,it would like to export to Thailand to take advantage of the fact that few roller blades are currentlysold in Thailand. Both of these factors suggest that the imperfect markets theory applies to Blades inthe short run. In the long run, the goal is to possibly establish a subsidiary in Thailand and to be oneof the first roller blade manufacturers in Thailand. The superiority of its production process suggests

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