International Business chapter 15

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ISG BBA PROGRAM Spring semester
BUS 470 International Business
Lecture 10 International Finance Management
in I.B
Financing, Transfers and Cash-Flows
Chapter 15
Tuesday, April 3rd 2007
Guillaume Sarrat de Tramezaigues
www.gstblog.com
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Scope of 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

• 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

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Project and Parent Cash Flows

• 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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Adjusting for Political and Economic Risk

• 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
• Collapse of communism in Eastern Europe
• Attack on the World Trade Center
• Economic risk
• Inflation

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Financing Decisions

• When considering options for financing a foreign
  investment, international businesses have to
  consider two factors
• Source of financing
• Financial structure

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Financing Decisions and 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
• Corporations
• Individuals
• Non-bank financial institutions
• Those who want to borrow money include
• Individuals
• Companies
• Governments

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Financing Decisions and The Global Capital Market

• Capital market loans to corporations re either
• Equity loans occur when corporations sell stock
  to investors
• 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
• Cost of capital is the price of borrowing money,
  which is the rate of return that borrowers must
  pay investors
• In a purely 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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Source of Financing

• Global capital markets for lower cost financing.
• Impact of 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/depreciatio
  n) influences capital and financing decisions

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Financial Structure

• 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 companys image
• Best recommendation adopt a financial structure
  that minimizes the cost of capital

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Global Money Management-The Efficiency Objective

• 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

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Global Money ManagementThe Tax Objective

• 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

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Moving Money Across Borders Attaining
Efficiencies and Reducing Taxes

• 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

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Dividend Remittances

• Most common method of transfer
• Dividend varies with
• Tax regulations
• Foreign exchange risk
• Age of subsidiary
• Extent of local equity participation

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Royalty Payments and Fees

• 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

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Transfer Prices

• Price at which goods or services are transferred
  within a firms 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

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Benefits of ManipulatingTransfer Prices

• 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

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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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Fronting Loans

• 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

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Tax Advantages of Fronting Loans
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Techniques for Global Money Management

• 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

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Techniques for Global Money Management

• Ability to reduce transaction costs
• Bilateral netting
• Multilateral netting simply extending the
  bilateral concept to multiple subsidiaries within
  an international business