Direct Foreign Investment

1
Chapter 13

• Direct Foreign Investment

2
Motivations for International Business

• Attract new demand
• Enter new markets
• Take advantage of economies of scale
• Use foreign FOP
• Obtain raw materials
• Exploit foreign technology

3
Motivations for International Business

• Exploit monopolistic advantage
• Diversify
• React to trade restrictions
• Take advantage of favorable taxation
• Take advantage of strong currency

4
Process of Overseas Expansion

• Exporting
• Licensing
• DFI
• 4 primary modes of entry
• Wholly owned subsidiary
• Joint venture
• Merger or acquisition
• Strategic alliance

5
Process of Overseas Expansion

• Wholly owned subsidiary
• Advantages
• Disadvantages

6
Process of Overseas Expansion

• Joint venture
• Advantages
• Disadvantages

7
Process of Overseas Expansion

• Merger or acquisition
• Advantages
• Disadvantages

8
Process of Overseas Expansion

• Strategic alliance
• Advantages
• Disadvantages

9
Example of DFI Decision

• Firm A located in the US
• Current return 18
• Current ? 5
• Proposed project
• U.S. S.Korea
• Return 20 20
• ? 4 6
• r .90 .04
• If adopted, new project would constitute 25 of
  firms business (existing business 75)

10
Example of DFI Decision

• Scenario 1 Subsidiary is located in US
• Return is given as
• Rfirm 0.75(0.18) 0.25(0.20) 18.5
• Risk is given as
• Variance (wa)2(?a)2 (wb)2(?b)2 2wawb?a?brab
• (0.75)2(0.05)2(0.25)2(0.04)22(0.75)(0.25)(0.05)(
  0.04)(0.90) 0.0022
• ? 4.69

11
Example of DFI Decision

• Scenario 2 Subsidiary is located in S. Korea
• Return is given as
• Rfirm 0.75(0.18) 0.25(0.20) 18.5
• Risk is given as
• Variance (wa)2(?a)2 (wb)2(?b)2 2wawb?a?brab
• (0.75)2(0.05)2(0.25)2(0.06)22(0.75)(0.25)(0.05)(
  0.06)(0.04) 0.001665
• ? 4.08

12
Example of DFI Decision

• Where should the firm locate its subsidiary?
• Why?

13
Possible Pitfalls

• Country risk
• Infrastructure limitations
• Long term nature

14
Summary

• DFI can take many forms
• DFI is generally more risk but the potential
  rewards are also greater
• Investing in economies that are not highly
  correlated represents the best strategy for
  reducing risk