17. International Joint Venture. Anheuser-Busch, (which is now part of AB InBev due to a merger),  the producer of Budweiser and other beers, has engaged in a joint venture with Kirin Brewery, the  largest brewery in Japan.  The joint venture enables Anheuser-Busch to have its beer distributed      through Kirin’s distribution channels in Japan.  In addition, it could utilize Kirin’s facilities to         produce beer that would be sold locally.  In return, Anheuser-Busch provided information about the American beer market to Kirin.

a.   Explain how the joint venture enabled Anheuser-Busch to achieve its objective of maximizing shareholder wealth.

ANSWER:  The joint venture creates a way for Anheuser-Busch to distribute Budweiser throughout Japan.  It enables Anheuser-Busch to penetrate the Japanese market without requiring a substantial  investment in Japan.

b.   Explain how the joint venture limited the risk of the international business.

ANSWER:  The joint venture has limited risk because Anheuser-Busch does not need to establish its own distribution network in Japan.  Thus, Anheuser-Busch may be able to use a smaller investment  for the international business, and there is a higher probability that the international business will be successful.

c.   Many international joint ventures are intended to circumvent barriers that normally prevent   foreign competition.  What barrier in Japan did Anheuser-Busch circumvent as a result of the joint venture?  What barrier in the United States did Kirin circumvent as a result of the joint  venture?

ANSWER: Anheuser-Busch is able to benefit from Kirin’s distribution system in Japan, which would not normally be so accessible. Kirin is able to learn more about how Anheuser-Busch expanded its     product across numerous countries, and therefore breaks through an “information” barrier.

d.   Explain how Anheuser-Busch could have lost some of its market share in countries outside Japan as a result of this particular joint venture.

ANSWER:  Anheuser-Busch could lose some of its market share to Kirin as a result of explaining its worldwide expansion strategies to Kirin.  However, it appears that Anheuser-Busch expects the         potential benefits of the joint venture to outweigh any potential adverse effects.

19. Valuation of an MNC. Birm Co., based in Alabama, is considering several international                     opportunities in Europe that could affect the value of its firm. The valuation of its firm is dependent    on four factors: (1) expected cash flows in dollars, (2) expected cash flows in euros that are ultimately converted into dollars, (3) the rate at which it can convert euros to dollars, and (4) Birm’s weighted    average cost of capital. For each opportunity, identify the factors that would be affected.

a.   Birm plans a licensing deal in which it will sell technology to a firm in Germany for $3,000,000;

the payment is invoiced in dollars, and this project has the same risk level as

its existing businesses.

b.   Birm plans to acquire a large firm in Portugal that is riskier than its existing businesses.

c.   Birm plans to discontinue its relationship with a U.S. supplier so that can import a small amount of supplies (denominated in euros) at a lower cost from a Belgian supplier.

d.   Birm plans to export a small amount of materials to Ireland that are denominated in euros.

ANSWER:

20. Assessing Motives for International Business. Fort Worth Inc. specializes in manufacturing some  basic parts for sports utility vehicles that are produced and sold in the U.S. Its main advantage in the U.S. is that its production is efficient, and less costly than that of some other unionized                      manufacturers. It has a substantial market share in the U.S. Its manufacturing process is labor-           intensive. The company pays relatively low wages compared to U.S. competitors, but it has               guaranteed the local workers that their positions will not be eliminated for the next 30 years.  It hired a consultant to determine whether it should set up a subsidiary in Mexico, where the parts would be  produced. The consultant suggested that Forth Worth expand for the following reasons. Offer your   opinion on whether the consultant’s reasons are logical:

a.   Theory of Competitive Advantage: There are not many SUVs sold in Mexico; hence, Fort Worth Inc. would not face much competition there.

b.   Imperfect Markets Theory: Fort Worth Inc. can not easily transfer workers to Mexico, but it can establish a subsidiary there in order to penetrate a new market.

c.   Product Cycle Theory: Fort Worth Inc. has been successful in the U.S. It has limited growth       opportunities because it already controls much of the U.S. market for the parts it produces. Thus, the natural next step is to conduct the same business in a foreign country.

d.   Exchange Rate Risk. The exchange rate of the peso has weakened recently, so this would allow Fort Worth Inc. to build a plant at a very low cost (by exchanging dollars for the cheap pesos to build the plant).

e.   Political Risk. The political conditions in Mexico have stabilized in the last few months, so Fort        Worth should attempt to penetrate the Mexican market now.

ANSWER: None of the arguments by the consultant are logical. If SUVs are not sold in the Mexican market, there is no need for these parts in Mexico. Fort Worth Inc. should only attempt to penetrate a new market if there is demand. Just because it has limited growth potential in the U.S., this does not  mean that there will be demand for its product in Mexico. Even if the exchange rate is low relative to recent periods, it could decline further, which would adversely affect any the dollar amount of future remitted earnings. Stable political conditions in Mexico are not a sufficient reason to pursue direct    foreign investment there.

24. Uncertainty Surrounding an MNC’s Valuation. Carlisle Co. is a U.S. firm that is about to purchase a large company in Switzerland for $20 million. This company produces furniture and sells it locally  (in Switzerland), and it is expected to earn large profits every year. The company will become a          subsidiary of Carlisle and will periodically remit the excess cash flows from to its profits to Carlisle    Co. Assume that Carlisle Co. has no other international business. Carlisle has $10 million that it will   use to pay for part of the Swiss company and will finance the rest of its purchase with borrowed          dollars. Carlisle Co. can obtain supplies from either a U.S. supplier or a Swiss supplier (in which case the payment would be made in Swiss francs).  Both suppliers are reputable and there would be no       exposure to country risk when using one supplier. Is the valuation of the total cash flows of Carlisle    Co. more uncertain if it obtains its supplies from a U.S. firm or a Swiss firm? Explain briefly.

ANSWER:  The valuation of Carlisle Co. is more uncertain if it uses a U.S. supplier because it will   have a larger amount of cash flows that will be remitted from Switzerland and converted into dollars. If it obtains supplies from Switzerland, it can use a portion of its Swiss franc cash flows to cover the cost, and will convert a smaller amount of francs into dollars on a periodic basis. Thus, it is less         exposed when sourcing from Switzerland.

Chapter 6

3. Direct Intervention. How can a central bank use direct intervention to change the value of a               currency? Explain why a central bank may desire to smooth exchange rate movements of its currency.

ANSWER:  Central banks can use their currency reserves to buy up a specific currency in the foreign exchange market in order to place upward pressure on that currency.  Central banks can also attempt to force currency depreciation by flooding the market with that specific currency (selling that             currency in the foreign exchange market in exchange for other currencies).

Abrupt movements in a currency’s value may cause more volatile business cycles, and may cause more concern in financial markets (and therefore more volatility in these markets).  Central bank intervention used to smooth exchange rate movements may stabilize the economy and financial   markets.

4. Indirect Intervention. How can a central bank use indirect intervention to change the value of a currency?

ANSWER:  To increase the value of its home currency, a central bank could attempt to increase        interest rates, thereby attracting a foreign demand for the home currency to buy high-yield securities.

To decrease the value of its home currency, a central bank could attempt to lower interest rates in order to reduce demand for the home currency by foreign investors.

10. Intervention Effects on Bond Prices. U.S. bond prices are normally inversely related to U.S. inflation. If the Fed planned to use intervention to weaken the dollar, how might bond prices be affected?

ANSWER:  Expectations of a weak dollar can cause expectations of higher inflation, because a weak dollar places upward pressure on U.S. prices for reasons mentioned in the chapter.  Higher inflation   tends to place upward pressure on interest rates.  Because there is an inverse relationship between      interest rates and bond prices, bond prices would be expected to decline.  Such an expectation causes bond portfolio managers to liquidate some of their bond holdings, thereby causing bond prices to       decline immediately.

16. Monitoring the Fed’s Intervention. Why do foreign market participants monitor the Fed’s direct      intervention efforts?  How does the Fed attempt to hide its intervention actions? The media frequently reports that “the dollar’s value strengthened against many currencies in response to the Federal           Reserve’s plan to increase interest rates.”  Explain why the dollar’s value may change even before the Federal Reserve affects interest rates.

ANSWER:  Foreign market participants make investment and borrowing decisions that can be           influenced by anticipated exchange rate movements and therefore by the Fed’s direct intervention      efforts.  Thus, they may attempt to obtain information from commercial banks about the Fed’s            intervention actions.  The Fed may attempt to disguise its actions by requesting bid and ask quotes on exchange rates, and even mixing some buy orders with sell orders, or vice versa.

Foreign exchange market participants may anticipate that once the Fed increases interest rates, there will be an increased demand for dollars, which will result in a stronger dollar.  Consequently, they   may take positions in dollars immediately, which could place upward pressure on the dollar even     before interest rates are affected.

19. Pegged Currencies. Why do you think a country suddenly decides to peg its currency to the dollar or some other currency? When a currency is unable to maintain the peg, what do you think are the          typical forces that break the peg?

ANSWER: A country will usually attempt a peg to reduce speculative flows that occur because of     exchange rate volatility. It tries to comfort investors by making them believe that the currency will be stable. In some cases, the peg is broken when there are adverse conditions in the country that make    investors believe that the peg will be broken. For example, foreign investors

become concerned that if the peg breaks, the currency may decline by 20 percent or more against their home currency. This would adversely affect the return on their investment, so they attempt to liquidate their investment and move their funds out of that currency before the peg breaks. If many investors have this concern simultaneously, they are all selling that currency at the same time. They place downward pressure on the currency because there is a larger supply of the   currency for sale than the demand for the currency. The central bank may attempt to offset these    forces by buying the currency in the foreign exchange market. However, it has a limited amount of that currency as a reserve and may be overwhelmed by market forces.

Practice Solutions 01

Additional Questions Providedfor Revision Purposes Only (Notfor the tutorial)

Chapter 1

5. International Opportunities Due to the Internet.

a.   What factors cause some firms to become more internationalized than others?

ANSWER: The operating characteristics of the firm (what it produces or sells) and the risk perception  of international business will influence the degree to which a firm becomes internationalized. Several    other factors such as access to capital could also be relevant here. Firms that are labor-intensive could  more easily capitalize on low-wage countries while firms that rely on technological advances could not.

b.   Offer your opinion on why the Internet may result in more international business.

ANSWER: The Internet allows for easy and low-cost communication between countries, so that firms could now develop contacts with potential customers overseas by having a website. Many firms use   their website to identify the products that they sell, along with the prices for each product.  This          allows them to easily advertise their products to potential importers anywhere in the world without     mailing brochures to various countries.  In addition, they can add to their product line and change       prices by simply revising their website, so importers are kept abreast of the exporter’s product             information by monitoring the exporter’s website periodically. Firms can also use their websites to     accept orders online.   Some firms with an international reputation use their brand name to advertise   products over the internet.  They may use manufacturers in some foreign countries to produce some    of their products subject to their specification

12. Macro versus Micro Topics. Review the table of contents and indicate whether each of the chapters from Chapter 2 through Chapter 21 has a macro or micro perspective.

ANSWER:  Chapters 2 through 8 are macro, while Chapters 9 through 21 are micro.

25. Impact of Exchange Rates on MNC Value. Olmsted Co. has small computer chips assembled in      Poland and transports the final assembled products to the parent, where they are sold by the parent in  the U.S. The assembled products are invoiced in dollars. It uses Polish currency (the zloty) to produce these chips, and assembles them in Poland. The Polish subsidiary pays the employees in the local       currency (zloty). Olmsted Co. finances its subsidiary operations with loans from a Polish bank (in       zloty). The parent of Olmsted will send sufficient monthly payments (in dollars) to the subsidiary in   order to repay the loan and other expenses incurred by the subsidiary. If the Polish zloty depreciates   against the dollar over time, will that have a favorable, unfavorable, or neutral effect on the value of   Olmsted Co.? Briefly explain.

ANSWER: It will have a favorable effect because Olmsted incurs expenses in the zloty and it will be able to cover these expenses with fewer dollars if the zloty depreciates. It will also be able to repay   the zloty loan with fewer dollars if the zloty depreciates.

27. Exposure of MNCs to Exchange Rate Movements. Arlington Co. expects to receive 10 million      euros in each of the next 10 years. It will need to obtain 2 million Mexican pesos in each of the next  10 years. The euro is presently valued at $1.38 and is expected to depreciate by 2 percent each year.  The peso is valued at $.13 and is expected to depreciate by 2 percent each year. Review the valuation equation for an MNC. Do you think that the exchange rate movements will have a favorable or          unfavorable effect on the MNC?

ANSWER: The movements in the euro are expected to have an unfavorable effect on Arlington’s     value. The expected movements in the peso are expected to have a favorable effect on Arlington’s    value. However, the expected peso effect should be smaller because the dollar amount of business in pesos is smaller. Thus, the overall effect should be unfavorable.

29. Exposure of MNCs to Exchange Rate Movements. Because of the low labor costs in Thailand,    Melnick Co. (based in the United States) recently established a major research and development      subsidiary there. The wholly-owned subsidiary was created to improve new products that the parent of Melnick can sell in the United States (denominated in dollars) to U.S. customers. The subsidiary pays its local employees in baht (the Thai currency). The subsidiary has a small amount of sales      denominated in baht, but its expenses are much larger than its revenue. It has just obtained a large   baht-denominated loan that will be used to expand its subsidiary. The business that the parent of     Melnick Co. conducts in the United States is not exposed to exchange rate risk. If the Thai baht       weakens over the next 3 years, will the value of Melnick Co. be favorably affected, unfavorably      affected, or unaffected? Briefly explain.

ANSWER: It will be favorably affected since it needs fewer dollars over time to cover its loan            payments and its baht expenses. Its revenue is mostly in dollars and therefore will not be significantly affected by a depreciation of the baht.

32. MNC Cash Flows and Exchange Rate Risk. Asheville Co. has a subsidiary in Mexico that              develops software for its parent. It rents a large facility in Mexico and hires many people in Mexico to work in the facility. Ashville Co. has no other international business. All operations are presently        funded by Asheville’s parent. All the software is sold to U.S. firms by Asheville’s parent and is           invoiced in U.S. dollars.

a.   If the Mexican peso appreciates against the dollar, does this have a favorable effect, an unfavorable effect, or no effect on Asheville’s value?

b.   Asheville Co. plans to borrow funds to support its expansion in the U.S. The Mexican interest     rates are presently lower than U.S. interest rates, so Asheville obtains a loan denominated in        Mexican pesos in order to support its expansion in the U.S. Will the borrowing of pesos increase, decrease, or have no effect on its exposure to exchange rate risk? Briefly explain.