Slide international business 6e by CHarless hill 07IBChapter 20

Project and Parent Cash Flows- 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

Chapter Twenty

Financial Management in the

International Business

Scope of Financial Management

sets of related decisions:

- Decisions about what activities to finance

- Decisions about how to finance those activities

- Decisions about how to manage the firm’s financial

resources most efficiently

Investment Decisions

• Capital budgeting:

- Quantifies the benefits, costs and risks of an

investment

- Managers can reasonably compare different

investment alternatives within and across countries

Project and Parent Cash Flows

- 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

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

- Inflation

Financing Decisions

investment, international businesses have to

consider two factors

- Source of financing

- Financial structure

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

- Governments

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

Financing Decisions and The Global Capital Market

Source of Financing

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

(appreciation/depreciation) influences capital and

financing decisions

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

that minimizes the cost of capital

Global Money Management

- Money market accounts - low interest - high liquidity

- Certificates of deposit - higher interest - lower liquidity

- Transaction costs: changing from one currency to

another

- Transfer fee: fee for moving cash from one location to

another

Global Money Management

The Tax Objective

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

2004 Corporate Tax Rates

Moving Money Across Borders:

Attaining Efficiencies and Reducing Taxes

funds from a foreign subsidiary to the parent

company without piquing the host country

- Dividend remittances

- Royalty payments and fees

- Transfer Prices

- Fronting loans

foreign subsidiary is part owned by a local

joint-venture partner or local stockholders

Dividend Remittances

Royalty Payments and Fees

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

or expertise supplied to subsidiary

- Management fees or ‘technical assistance’ fees

Transfer Prices

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

Benefits of Manipulating

Transfer Prices

shift from a high-tax country to a low-tax country

expected currency devaluation by transferring

funds

blocked by host-government policy

transfer prices and the value of the goods

Problems With Transfer Pricing

- Believe (rightly) that they are losing revenue

performance evaluations

- Inconsistent with a ‘profit center’

- Managers can hide inefficiencies

Fronting Loans

channeled through a financial intermediary (bank)

- Allows circumvention of host country restrictions on

remittance of funds from subsidiary to parent

- Provides certain tax advantages

Tax Advantages of Fronting Loans

Techniques for Global Money Management

insuring against negative cash flows

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

Centralized Depositories

Techniques for Global Money Management

Cash Flows Before Multilateral Netting

Cash Flows After Multilateral Netting