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International business by czinkota 7ech17

Chapter 17
Financial Management


Learning Objectives
To understand how value is measured
and managed across the multiple units
of the multinational firm.
To understand how international business
and investment activity alters and adds to
the traditional financial management activities
of the firm.
To understand the three primary currency
exposures that confront the multinational firm.
To examine how exchange rate changes alter
the value of the firm, and how management can
manage or hedge these exposures.

The Goal of Management
The goal for most Anglo-American markets is
stockholder maximization - the management
of the company seeks to maximize the returns
to stockholders by working to push share
prices up and to continually grow dividends.
The goal for most Continental European and
Japanese firms is corporate wealth
maximization - considering the financial and
social health of all stakeholders.


Global Financial Goals
The three primary
financial objectives are:
1. Maximization of
consolidated, after-tax
2. Minimization of the firm’s
effective global tax burden.
3. Correct positioning of the
firm’s income, cash flows,
and available funds.

Genus Corporation and
Foreign Subsidiaries
Genus Corporation

Moderate Tax
Unstable Currency
Limited Funds Movement


High Tax
Stable Currency
Free Funds Movement

Low Tax
Stable Currency
Blocked Funds

Multinational Management at
The primary goal of the firm is the maximization of
consolidated profits, after tax.
Consolidated profits are the profits of all the individual
units of the firm originating in many different
Each of the incorporated units of the firm has its own
set of traditional financial statements, which are
expressed in the local currency.
The shareholders of Genus track the firm’s financial
performance on the basis of earnings per share (EPS).
Each affiliate is located within a country’s borders and
is therefore subject to all laws and regulations within
that country.

Evaluating Potential Foreign
Evaluating the potential for foreign investment
Capital budgeting - the process of evaluating the financial
feasibility of an individual investment.
Capital structure - the determination of the relative
quantities of debt capital and equity capital that will
constitute the funding of the investment.
Working capital and cash flow management - the
management of operating the financial cash flows passing
in and out of a specific investment project.


Financial Trust
Unlike most domestic business, international
business often occurs between two parties that
do not know each other very well.
In order to conduct business, a large degree of
financial trust must exist.
Financial trust is the trust that the buyer
of a product will actually pay for it
on or after delivery.


Financial Trust Using a Letter
of Credit (L/C)

Yokohama Bank



Endaka Construction

Pacific First Bank
(United States)

Financing of trade
with L/C
pine lumber




Vanport Lumber
(United States)



Financial Trust Using a Letter
of Credit (L/C)
1. Endaka Construction requests a letter of credit to be
issued by its bank.
2. Yokohama Bank will determine if Endaka is financially
sound and capable of making the payments required.
3. Yokohama Bank issues the letter of credit to the
exporter’s bank, Pacific First Bank.
4. Pacific First assures Vanport that payment will be
made after evaluating the letter of credit.
5. The lumber order is loaded onboard the shipper.
6. Vanport draws a draft against Yokohama Bank for
7. Pacific Bank confirms the letter of credit and collects
from Yokohama Bank.

Multinational Investing
An investment is financially justified if it has a
positive net present value (NPV).
The construction of a capital budget is the
process of projecting the net operating cash
flows of the potential investment to determine
if it is indeed a good investment.
A capital budget is composed primarily of cash
flow components.


Capital Budget Components
Initial Expenses and
Capital Outlays

Operating Cash Flows

Terminal Cash Flows


Risks in International
Risks are higher for international investments
than domestic investments.
The risk arises from the different countries,
their laws, regulations, potential for
interference with the normal operations of the
investment project, and currencies.
Foreign governments have the ability to pass
new laws, increasing risk for a parent
Another risk issue is that the viewpoint or
perspective of the parent and the project may
no longer be the same.

International Cash Flow
Cash management is the financing of short-term
or current assets.
Operating cash flows arise from the everyday
business activities of the firm such as paying for
materials or resources or receiving payments for
items sold.
Financing cash flows arise from the funding
activities of the firm. The servicing of existing
funding resources, interest on existing debt, and
dividend payments to shareholders constitute
frequent cash flows.

Transfer Prices
The prices at which multinational
firms sell their products to their
subsidiaries and affiliates are
called transfer prices.
Theoretically, they are equivalent
to what the product would cost if
purchased on the open market.
Sometimes, transfer prices are set
internally, which may result in the
subsidiary being more or less

Cash Management
Netting, which combines cash flows between subsidiaries
and parent companies, is particularly helpful if the two
way flow is in two currencies.
Combining capital, or cash pooling, allows a firm to
spend less in terms of foregone interest on cash balances.
A foreign subsidiary that is expecting its local currency to
fall in value relative to that of the parent company may try
to speed up, or lead its payments to the parent.
If the local currency is expected to rise versus that of the
parent company, the subsidiary may want to wait, or lag

Cash Management (cont.)
Reinvoicing occurs when one

office in a multinational firm takes
ownership of all invoices and
payments between units.
An internal bank can be
established within a firm if its
financial resources and needs are
either too large or too sophisticated
for the financial services that are
available in local subsidiary markets.

Types of Foreign Currency
Transaction Exposure

Economic Exposure

Translation Exposure


Transaction Exposure
Transaction exposure is the risk associated
with a contractual payment of foreign
It is the most common type of exchange risk.
The two conditions necessary for a
transaction exposure to exist are:
1. A cash flow that is denominated in a foreign
2. The cash flow will occur at a future date.


Transaction Exposure (cont.)
Managing transaction exposures usually is
accomplished by either natural hedging or
contractual hedging.
Natural hedging describes how a firm might arrange to
have foreign currency cash flows coming in and going
out at roughly the same times and same amounts.
Contractual hedging is when a firm uses financial
contracts to hedge the transaction exposure. The
most common foreign currency contractual hedge is
the forward contract.

Firms that import or export on a continuing basis
have constant transaction exposures.

Economic Exposure
Economic exposure is the risk to the firm that

its long-term cash flows will be affected,
positively or negatively, by unexpected future
exchange rate changes.

It emphasizes that there is a limit to a firm’s
ability to predict either cash flows or exchange
rate changes in the medium to long term.
Management of economic exposure is being
prepared for the unexpected.


Translation Exposure
Translation exposure is the
risk that arises from the legal
requirement that all firms
consolidate their financial
statements of all worldwide
operations annually.
Unlike transaction and economic
exposures, which are “true”
exposures, translation exposure
is an economic problem.

Countertrade is a sale that encompasses more
than an exchange of goods, services, or ideas for
Historically, countertrade was mainly conducted
in the form of barter, which is a direct exchange
of goods of approximately equal value, with no
money involved.
Conditions that encourage countertrade are:
lack of money,
lack of value of or faith in money,
lack of acceptability of money as an exchange
greater ease of transaction by using goods.

Reasons for Countertrade
Increasingly, countries and companies are
deciding that sometimes countertrade
transactions are more beneficial than
transactions based on financial exchange.
The use of countertrade permits the covert
reduction of prices and therefore allows the
circumvention of price and exchange controls.
Many countries are responding favorably to
the notion of bilateralism.
Countertrade is viewed as an excellent
mechanism to gain entry into new markets.

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