Chapter

1. 20 Chapter Financial Management in International Business

2. 60% of P &G’s revenues from international sales Products sold in 130 countries Has centralized global treasury management function Management of all foreign exchange transactions P& G trades currency between subsidiaries, cutting out banks and saving on transaction costs P & G is pooling foreign exchange risks and buying an purchasing an umbrella option to cover risks associated with various currency options Subsidiaries can invest in and borrow money from other P &G entities instead of dealing with banks Case: Global treasury management at Proctor & Gamble

3. Scope of financial management includes three sets of related decisions: Investment decisions Decisions about what activities to finance Financing decisions Decisions about how to finance those activities. Money management decisions Decisions about how to manage the firm’s financial resources most efficiently Scope of financial management

4. Capital budgeting: Quantifies the benefits, costs and risks of an investment Managers can reasonably compare different investment alternatives within and across countries Complicated process: Must distinguish between cash flows to project and those to parent Political and economic risk can change the value of a foreign investment Connection between cash flows to parent and the source of financing must be recognized Investment decisions

5. Project cash flows may not reach the parent: Host-country may block cash-flow repatriation Cash flows may be taxed at an unfavorable rate Host government may require a percentage of cash flows to be reinvested in the host country Project and parent cash flows

6. Political risk: Expropriation - Iranian revolution, 1979 Social unrest - after the breakup of Yugoslavia, company assets were rendered worthless Political change - may lead to tax and ownership changes Examples. Collapse of communism in Eastern Europe Attack on the world trade center Economic risk Inflation Adjusting for political and economic risk

7. When considering options for financing a foreign investment, Int. businesses have to consider two factors Source of financing Financial structure Financing decisions

8. Global capital markets for lower cost financing. Impact of host country-host-country may require projects to be locally financed through debt or equity Limited liquidity raises the cost of capital. Host-government may offer low interest or subsidized loans to attract investment. Impact of local currency (appreciation/depreciation) influences capital and financing decisions Source of financing

9. Financial structure: Debt/equity ratios vary with countries. Tax regimes Follow local capital structure norms? More easily evaluate return on equity relative to local competition Good for company’s image Best recommendation: adopt a financial structure that minimizes the cost of capital Financial structure

10. Minimizing cash balances: Money market accounts - low interest - high liquidity Certificates of deposit - higher interest - lower liquidity Reducing transaction costs (cost of exchange): Transaction costs: changing from one currency to another Transfer fee: fee for moving cash from one location to another Global money management-The efficiency objective

11. Countries tax income earned outside their boundaries by entities based in their country. Can lead to double taxation Tax credit allows entity to reduce home taxes by amount paid to foreign government Tax treaty is an agreement between countries specifying what items will be taxed by authorities in country where income is earned Deferral principle specifies that parent companies will not be taxed on foreign income until the dividend is received Tax haven is used to minimize tax liability Global money managementThe tax objective

12. Corporate income tax rates

13. Unbundling:A mix of techniques to transfer liquid funds from a foreign subsidiary to the parent company without piquing the host-country Dividend remittances Royalty payments and fees Transfer Prices Fronting loans Selecting a particular policy is limited when a foreign subsidiary is part owned by a local joint-venture partner or local stockholders Moving money across borders:Attaining efficiencies and reducing taxes

14. Most common method of transfer. Dividend varies with: tax regulations. Foreign exchange risk. Age of subsidiary. Extent of local equity participation. Dividend remittances

15. Royalties represent the remuneration paid to owners of technology, patents or trade names for their use by the firm. Common for parent to charge a subsidiary for technology, patents or trade names transferred to it. May be levied as a fixed amount per unit sold or percentage of revenue earned. Fees are compensation for professional services or expertise supplied to subsidiary. Management fees or ‘technical assistance’ fees. Fixed charges for services provided Royalty payments and fees

16. Price at which goods or services are transferred within a firm’s entities. Position funds within a company. Move founds out of country by setting high transfer fees or into a country by setting low transfer fees. Movement can be within subsidiaries or between the parent and its subsidiaries. Transfer prices

17. Reduce tax liabilities by using transfer fees to shift from a high-tax country to a low-tax country. Reduce foreign exchange risk exposure to expected currency devaluation by transferring funds. Can be used where dividends are restricted or blocked by host-government policy. Reduce import duties (ad valorem) by reducing transfer prices and the value of the goods. Benefits of manipulating transfer prices

18. Few governments like it. Believe (rightly) that they are losing revenue. Has an impact on management incentives and performance evaluations. Inconsistent with a ‘profit center’. Managers can hide inefficiencies. Problems with transfer pricing

19. Loan between a parent and subsidiary is channeled through a financial intermediary (bank). Allows circumvention of host-country restrictions on remittance of funds from subsidiary to parent. Provides certain tax advantages. Fronting loans

20. An example of the tax aspects of a fronting loan Fig 20.1

21. Need cash reserves to service accounts and insuring against negative cash flows. Should each subsidiary hold its own cash balance? By pooling, firm can deposit larger cash amounts and earn higher interest rates. If located in a major financial center can get information on good investment opportunities. Can reduce the total size of cash pool and invest larger reserves in higher paying, long term, instruments. Techniques for global money management

22. Centralized depositories

23. Ability to reduce transaction costs. Bilateral netting. Multilateral netting - simply extending the bilateral concept to multiple subsidiaries within an international business Techniques for global money management

24. Cash flows before multilateral netting Fig 20.2A

25. Cash flows after multilateral netting Fig 20.2C

26. Net receipts Fig 20.2B

27. Risk that future changes in a country’s exchange rate will hurt the firm. Transaction exposure: extent income from transactions is affected by currency fluctuations. Translation exposure: impact of currency exchange rates on consolidated results and balance sheet. Economic exposure: effect of changing exchange rates over future prices, sales and costs. Managing foreign exchange risk

28. Primarily protect short-term cash flows. Reducing transaction and translation exposure: Buying forward and currency swaps. Lead strategy: collecting receivables early when currency devaluation is anticipated and paying early when currency may appreciate. Lag strategy: delaying receivable collection when anticipating currency appreciation and delaying payables when currency depreciation is expected. Strategies for reducing foreign exchange risk (a)

29. Reducing Transaction and translation exposure Lead strategy Lag strategy Reducing economic exposure: Key is to distribute productive assets to various locations so firm is not severely affected by exchange rate changes Strategies for reducing foreign exchange risk (b)

30. No agreement as to how, but commonality of approach does exist: Central control of exposure. Distinguish between transaction/translation exposure and economic exposure. Forecast future exchange rate movements. Good reporting systems to monitor firm’s exposure to exchange rate changes. Produce monthly foreign exchange exposure reports. Managing Foreign Exchange Exposure

31. Case: Motorola’s global cash management system Pre netting and post netting info flows Fig C2 Fig C1

32. Case: Motorola’s global cash management system Fig C1

33. Case: Motorola’s global cash management system: Currency netting model Fig C3

34. Case: Motorola’s global cash management system