Financial Management in International Business

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Financial Management in International Business

• Dr. Carol Reade
• Bus 187

2
Objectives

• Introduce the scope of financial management in
  international business
• Understand what is involved in
• investment decisions
• financing decisions
• money management decisions
• Appreciate host country concerns

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What is Financial Management?

• 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 firms
  financial resources most efficiently

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Investment Decisions

• What activities to finance?
• Capital budgeting
• Quantifies the benefits, costs and risks of an
  investment
• Managers can reasonably compare different
  investment alternatives within and across
  countries

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Investment Decisions

• Complicated process across countries
• Political and economic risk can change the value
  of a foreign investment
• Must distinguish between cash flows to the
  project and cash flows to the parent, since
  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

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Financing Decisions

• How should the activities be financed?
• When considering options for financing a foreign
  investment, international businesses have to
  consider two factors
• Source of financing
• Financial structure

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The Global Capital Market

• A capital market brings together those who want
  to invest money and those who want to borrow
  money
• Those who want to invest money include
• Individuals, Companies, Non-bank financial
  institutions
• Those who want to borrow money include
• Individuals, Companies, Governments

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The Global Capital Market

• Capital market loans to corporations are either
• Equity loans occur when a corporation sells stock
  to investors, and gives shareholders a claim to
  the firms profit stream
• Debt loans occur when a corporation borrows money
  and agrees to repay a predetermined portion of
  the loan amount at regular intervals regardless
  of how much profit it is making
• Cash loans from bank
• Funds raised from sale of corporate bonds

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The Global Capital Market

• Cost of capital is the price of borrowing money,
  which is the rate of return that borrowers must
  pay investors
• Is the cost of capital the same in the domestic
  versus the global capital market?

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The Global Capital Market

• In a domestic capital market the pool of
  investors is limited to residents of the country
• Places an upper limit on the supply of funds
  available
• Increases the cost of capital
• A global capital market provides a larger supply
  of funds for borrowers to draw on
• Lowers the cost of capital

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The Case of China Mobile

• http//www.chinamobileltd.com/mf.php?menu4

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Financing Decisions and the Global Capital Market
- China Mobile
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Source of 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
• Local currency (appreciation/depreciation)
  influences capital and financing decisions

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Consider

• You are the CFO of a US firm whose wholly-owned
  subsidiary in Mexico manufactures component parts
  for your US assembly operations. The subsidiary
  has been financed by bank borrowings in the US.
  One of your analysts told you that the Mexican
  peso is expected to depreciate by 30 against the
  US dollar over the next year.
• What actions, if any, should you take?

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Money Management Decisions

• How to best manage the firms resources?
• Moving money across borders to attain
  efficiencies and reduce taxes
• Techniques to transfer liquid funds from a
  foreign subsidiary to the parent company
• Dividend remittances
• Royalty payments and fees
• Fronting loans
• Transfer Prices

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Transfer Prices

• Price at which goods or services are transferred
  within a firms entities
• Used to position funds within an international
  business
• Move funds out of a country by setting high
  transfer prices for goods/services supplied to
  subsidiary within that country, and by setting
  low transfer prices for goods/services sourced
  from that country.
• Movement can be within subsidiaries or between
  the parent and its subsidiaries

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Benefits of Transfer Pricing

• Reduce tax liabilities by using transfer prices
  to shift from a high-tax country to a low-tax
  country
• Reduce exposure to foreign exchange risk by using
  transfer prices to shifting funds out of a
  country where significant devaluation is expected
• Can be used where dividends are restricted or
  blocked by host-government policy
• Reduce import duties (ad valorem tariff) by
  reducing transfer prices and the value of the
  goods

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Problems With Transfer Pricing

• 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

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Summary Points

• The scope of financial management in
  international business includes
• investment decisions
• financing decisions
• money management decisions
• Firms need to appreciate host country concerns
  and consider the ethics involved