BUS330: International Finance Workshop 01
Hello, dear friend, you can consult us at any time if you have any questions, add WeChat: daixieit
BUS330: International Finance
Workshop 01 (Chapter 1): Multinational Financial Management: An Overview
Solutions to Problems
1. Agency problems of MNCs
a. Explain the agency problem of MNCs.
ANSWER: The agency problem reflects a conflict of interests between decision- making managers and the owners of the MNC. Agency costs occur in an effort to assure that managers act in the best interest of the owners.
b. Why might agency costs be larger for an MNC than for a purely domestic company?
ANSWER: The agency costs are normally larger for MNCs than purely domestic companies for the following reasons. First, MNCs incur larger agency costs in monitoring managers of distant foreign subsidiaries. Second, foreign subsidiary managers raised in different cultures may not follow uniform goals. Third, the sheer size of the larger MNCs would also create large agency problems.
2. Comparative advantage
a. Explain how the theory of comparative advantage relates to the need for international business.
ANSWER: The theory of comparative advantage implies that countries should specialise in production, thereby relying on other countries for some products. Consequently, there is a need for international business.
b. Explain how the product cycle theory relates to the growth of an MNC.
ANSWER: The product cycle theory suggests that at some point in time, the company will attempt to capitalise on its perceived advantages in markets other than where it was initially established.
3. Imperfect markets
a. Explain how the existence of imperfect markets has led to the establishment of subsidiaries in foreign markets.
ANSWER: Because of imperfect markets, resources cannot be easily and freely retrieved by the MNC. Consequently, the MNC must sometimes go to the resources rather than retrieve resources (such as land, labour, etc.).
b. If perfect markets existed, would wages, prices and interest rates among countries be more similar or less similar than under conditions of imperfect markets? Why?
ANSWER: If perfect markets existed, resources would be more mobile and could therefore be transferred to those countries more willing to pay a high price for them. As this occurred, shortages of resources in any particular country would be alleviated and the costs of such resources would be similar across countries.
4. International opportunities
a. Do you think the acquisition of a foreign company or licensing will result in greater growth for an MNC? Which alternative is likely to have more risk?
ANSWER: An acquisition will typically result in greater growth, but it is more risky because it normally requires a larger investment and the decision cannot be easily reversed once the acquisition is made.
b. Describe a scenario in which the size of a corporation is not affected by access to international opportunities.
ANSWER: Some companies may avoid opportunities because they lack knowledge about foreign markets or expect that the risks are excessive. Thus, the size of these companies is not affected by the opportunities.
c. Explain why MNCs such as Coca-Cola and PepsiCo, Inc., still have numerous opportunities for international expansion.
ANSWER: Coca-Cola and PepsiCo still have new international opportunities because countries are at various stages of development. Some countries have just recently opened their borders to MNCs. Many of these countries do not offer sufficient food or drink products to their consumers.
6. Impact of exchange rate movements Globe International of Melbourne has several Asian subsidiaries that remit earnings to it each year. Explain how appreciation of the Chinese yuan would Globe International’s valuation.
ANSWER: Globe International’s valuation should increase because the appreciation of the Chinese yuan will increase the Australian dollar value of the cash flows remitted by the Asian subsidiaries.
7. Benefits and risks of international business As an overall review of this chapter, identify possible reasons for growth in international business. Then, list the various disadvantages that may discourage international business.
ANSWER: Growth in international business can be stimulated by (1) access to foreign resources which can reduce costs, or (2) access to foreign markets which boost revenues. Yet, international business is subject to risks of exchange rate fluctuations, and political risk (such as a possible host government takeover, tax regulations, etc.).
11. Exposure to exchange rates Australian Vintage has a French subsidiary that produces wine and exports to various European countries. All of the countries where it sells its wine use the euro as their currency, which is the same as the currency used in France. Is Australian Vintage exposed to exchange rate risk?
ANSWER: The subsidiary and its customers based in countries that now use the euro as their currency would no longer be exposed to exchange rate risk. However, Australian Vintage is exposed to exchange rate risk, because the subsidiary will ultimately remit its earnings to the parent, and the euro earnings will be converted to Australian dollars when they are remitted.
14. International business methods Sydney Golf Co., an Australian company that sells high-quality golf clubs in Australia, wants to expand internationally by selling the same golf clubs in China.
a. Describe the trade-offs that are involved for each method (such as exporting, direct foreign investment, etc.) that Sydney Golf Co. could use to achieve its goal.
ANSWER: Sydney can export the clubs, but the transportation expenses may be high. It could establish a subsidiary in China to produce and sell the clubs, but this may require a large investment of funds. It could use licensing, in which it specifies to a Chinese company how to produce the clubs. In this way, it does not have to establish its own subsidiary there.
b. Which method of international method would you recommend for this company? Justify your recommendation.
ANSWER: If the amount of golf clubs to be sold in China is small, it may decide to export. However, if the expected sales level is high, it may benefit from licensing. If it is confident that the expected sales level will remain high, it may be willing to establish a subsidiary. The wages are lower in China and the large investment needed to establish a subsidiary may be worthwhile.
17. International joint venture An Australian-based beer company, Coopers Brewery Ltd., a producer of world-class beers, has engaged in a joint venture with Kirin Brewery, the largest brewery in Japan. The joint venture enables Coopers to have its beer distributed through Kirin’s distribution channels in Japan. In addition, it can utilise Kirin’s facilities to produce beer that will be sold locally. In return, Coopers provides information about the Australian beer market to Kirin.
a. Explain how the joint venture enabled Coopers to achieve its objective of maximising shareholder wealth.
ANSWER: The joint venture creates a way for Coopers to distribute world-class beers throughout Japan. It enables Coopers 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 Coopers does not need to establish its own distribution network in Japan. Thus, Coopers 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 Coopers circumvent as a result of the joint venture? What barrier in Australia did Kirin circumvent as a result of the joint venture?
ANSWER: Coopers 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 Coopers expanded its product across numerous countries and therefore breaks through an ‘information’ barrier.
d. Explain how Coopers could have lost some of its market share in countries outside Japan as a result of this particular joint venture.
ANSWER: Coopers could lose some of its market share to Kirin as a result of explaining its worldwide expansion strategies to Kirin. However, it appears that Coopers expects the potential benefits of the joint venture to outweigh any potential adverse effects.
19. Valuation of an MNC TechnologyOne, based in Sydney, is considering several international opportunities in Asia that could affect the value of company. The valuation is dependent on four factors: (1) expected cash flows in Australian dollars,
(2) expected cash flows in different Asian currencies (Indian rupees, Chinese yuan and Malaysian ringgit) that are ultimately converted into Australian dollars, (3) the rate at which it can convert all Asian currencies in (2) to Australian dollars, and (4) TechnologyOne’s weighted average cost of capital. For each opportunity, identify the factors that would be affected.
a. TechnologyOne plans a licensing deal in which it will sell technology to a company in Hong Kong for A$3 million; the payment is invoiced in Australian dollars, and this project has the same risk level as its existing businesses.
b. TechnologyOne plans to acquire a large company in India that is riskier than its existing businesses.
c. TechnologyOne plans to discontinue its relationship with an Australian supplier so that can import a small amount of supplies (denominated in Chinese yuan) at a lower cost from a China supplier.
d. TechnologyOne plans to export a small amount of materials to Malaysia that are
denominated in Malaysian ringgits.
ANSWER:
Opportunity |
Australian dollar CF |
Asian currencies CF |
Exchange rate at which TechnologyOne converts Asian currencies to Australian dollars |
a. joint venture |
X |
|
|
b. acquisition |
|
X (rupee) |
X (A$/rupee) |
c. imported supplies |
|
X (yuan) |
X (A$/yuan) |
d. exports to Malaysia |
|
X (ringgit) |
X (A$/ringgit) |
22. Impact of international business on cash flows and risk Nantucket Travel Agency specialises in tours for American tourists. Until recently, all of its business was in the United States. It just established a subsidiary in Athens, Greece, which provides tour services in the Greek islands for American tourists. It rented a shop near the port of Athens. It also hired residents of Athens who could speak English and provide tours of the Greek islands. The subsidiary’s main costs are rent and salaries for its employees and the leasing of a few large boats in Athens that it uses for tours. American tourists pay for the entire tour in dollars at Nantucket’s main US office before they depart for Greece.
a. Explain why Nantucket may be able to effectively capitalise on international opportunities such as the Greek island tours.
ANSWER: It already has established credibility with American tourists, but could penetrate a new market with some of the same customers that it has served on tours in the US.
b. Nantucket is privately owned by people who reside in the United States and work in the main office. Explain possible agency problems associated with the creation of a subsidiary in Athens, Greece. How can Nantucket attempt to reduce these agency costs?
ANSWER: The employees of the subsidiary in Athens are not owners and may have no incentive to manage in a manner that maximises the wealth of the owners. Thus, they may manage the tours inefficiently. Nantucket could attempt to allow the employees a portion of the ownership of the company so that they benefit more directly from good performance. Alternatively, Nantucket may consider having one of its owners transfer to Athens to oversee the subsidiary’s operations.
c. Greece’s cost of labour and rent are relatively low. Explain why this information is relevant to Nantucket’s decision to establish a tour business in Greece.
ANSWER: The low cost of rent and labour will be beneficial to Nantucket, because it enables Nantucket to create the subsidiary at a low cost.
d. Explain how the cash flow situation of the Greek tour business exposes Nantucket to exchange rate risk. Is Nantucket favourably or unfavourably affected when the euro (Greece’s currency) appreciates against the dollar? Explain.
ANSWER: Nantucket’s tour business in Greece results in dollar cash inflows and euro cash outflows. It will be adversely affected by the appreciation of the euro because it will require more dollars to cover the costs in Athens if the euro’s value
rises.
e. Nantucket plans to finance its Greek tour business. Its subsidiary could obtain loans in euros from a bank in Greece to cover its rent and its main office could pay off the loans over time. Alternatively, its main office could borrow dollars and would periodically convert dollars to euros to pay the expenses in Greece. Does either type of loan reduce the exposure of Nantucket to exchange rate risk? Explain.
ANSWER: No. The euro loans would be used to cover euro expenses, but Nantucket would need dollars to pay off the loans. Alternatively, the US dollar loans would still require conversion of dollars to euros. With either type of loan, Nantucket is still adversely affected by the appreciation of the euro against the dollar.
f. Explain how the Greek island tour business could expose Nantucket to country risk.
ANSWER: The subsidiary could be subject to government restrictions or taxes in Greece that would place it at a disadvantage relative to other Greek tour companies based in Athens.
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 United States. The assembled products are invoiced in dollars. Olmsted Co. uses Polish currency (the zloty) to produce these chips and assemble 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 favourable, unfavourable, or neutral effect on the value of Olmsted Co.? Briefly explain.
ANSWER: It will have a favourable 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.
29. Exposure of MNCs to exchange rate movements Because of the low labour costs in Thailand, Melnick Co. (based in the United States) recently established a major research and development subsidiary there that it owns. The subsidiary was created to improve new products that the parent of Melnick can sell in the United States (denominated in dollars) to US 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 loan denominated in baht 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 three years, will the value of Melnick Co. be favourably affected, unfavourably affected, or unaffected? Briefly explain.
ANSWER: It will be favourably affected since it needs fewer US dollars over time to cover its loan payments and its baht expenses. Its revenue is mostly in US dollars and therefore will not be significantly affected by a depreciation of the baht.
31. MNC cash flows and exchange rate risk Tuscaloosa Co. is a US company that assembles phones in Argentina and transports the final assembled products to the parent, which sells them in the United States. The assembled products are invoiced in dollars. The Argentine subsidiary obtains some material from China, and the Chinese exporter is willing to accept Argentine pesos as payment for the materials that it exports. The Argentine subsidiary pays its employees in the local currency (pesos) and finances its operations with loans from an Argentine bank (in pesos). Tuscaloosa Co. has no other international business. If the Argentine peso depreciates against the US dollar over time, will that have a favourable, unfavourable, or neutral effect on Tuscaloosa Co.? Briefly explain.
ANSWER: Tuscaloosa Co. has no cash inflows in Argentine pesos, but has cash outflows in Argentine pesos. Therefore, it benefits if the peso depreciates because it can obtain pesos with fewer US dollars and can reduce its cost.
32. MNC cash flows and exchange rate risk Asheville Co. (an Australian company) has a subsidiary in India that develops software for its parent. It rents a large facility in India and hires many people to work there. Ashville Co. has no other international business. All operations are presently funded by Asheville’s parent. All the software is sold to Australian companies by Asheville’s parent and is invoiced in Australian dollars.
a. If the peso Indian rupee appreciates against the Australian dollar, does this have a favourable effect, an unfavourable effect, or no effect on Asheville’s value?
ANSWER: Appreciation of the rupee has an unfavourable effect because it results in higher Australian dollar expenses to Asheville Co.
b. Asheville Co. plans to borrow funds to support its expansion in Australia. The Indian interest rates are presently lower than Australian interest rates, so Asheville obtains a loan denominated in Indian rupees in order to support its expansion in Australia. Will the borrowing of rupees increase, decrease, or have no effect on its exposure to exchange rate risk? Briefly explain.
ANSWER: Borrowing rupees will increase Asheville's exposure because it will increase the amount of Australian dollar cash outflows that are needed to cover expenses.
33. Estimating an MNC's cash flows Biloxi Co. is an Australian company with a subsidiary in China. The subsidiary reinvests half of its net cash flows into operations and remits half to the parent. Biloxi Co. has expected cash flows from domestic business equal to A$10 million and the Chinese subsidiary is expected to generate
100 million Chinese yuan at the end of the year. The expected value of yuan at the end of the year is A$0.21. What are the expected dollar cash flows of the parent of Biloxi Co. in one year?
ANSWER: [A$10,000,000 + (100,000,000 yuan/2) x A$0.21/yuan] = A$20,500,000
34. Uncertainty surrounding an MNC's cash flows
a. Assume that Bangor Co. (an Australian company) knows that it will have cash inflows of A$900,000 from domestic operations, cash inflows of 200,000 Malaysian ringgit (MYR) due to export to Malaysian operations, and cash outflows of 500,000 Malaysian ringgit at the end of the year. While the future value of the Malaysian ringgit is uncertain because it fluctuates, your best guess is that the Malaysian ringgit’s value will be A$0.35 at the end of this year. What are the expected Australian dollar cash flows of Bangor Co?
ANSWER: [A$900,000 + (-300,000 ringgit x A$0.35/ringgit)] = A$795,000
b. Assume that Concord Co. (an Australian company) is in the same industry as Bangor Co. There is no political risk that could have any impact on the cash flows of either company. Concord Co. knows that it will have cash inflows of A$900,000 from domestic operations, cash inflows of 700,000 Malaysian ringgit due to export to Malaysian operations, and cash outflows of 800,000 Malaysian ringgit at the end of the year. Is the valuation of the total cash flows of Concord Co. more uncertain or less uncertain than the total cash flows of Bangor Co.? Explain briefly.
ANSWER: The cash flows of Bangor are more uncertain because a larger proportion of the cash flows are subject to exchange rate risk.
37. Exposure of MNC cash flows.
a. Rochester Co. is a US company that has a language institute in France. This institute attracts Americans who want to learn the French language. Rochester Co. charges tuition to the American students in US dollars. It expects that its dollar revenue from charging tuition will be stable over each of the next several years. Its total expenses for this business project are as follows. It rents a facility in Paris and makes a large rent payment each month in euros. It also hires several French citizens as full-time instructors and pays their salaries in euros. It expects that its expenses denominated in euros will be stable over each of the next several years. If the euro appreciates against the US dollar over time, should this have a favourable effect, unfavourable effect, or no effect on the value of Rochester Co.? Briefly explain.
ANSWER: It should have an unfavourable effect, because it will take more US dollars to cover the euro expenses over time. Thus, the net cash flows in US dollars generated by Rochester should decrease over time.
b. Rochester Co. considers a new project in which it would also attract people from Spain, and the institute in France would teach them the French language. It would charge them tuition fees in euros. The expenses for this project would be about the same as the expenses of the project described above for the American students. Also assume that euros to be generated by this project would be stable over the next several years. Assume that this project is about the same size as the project for American students. For either project, the expected annual revenue is just slightly larger than the expected annual expenses. Is the valuation of net cash flows subject to a higher degree of exchange rate risk for this project or for the project for American students? Briefly explain.
ANSWER: The valuation of net cash flows for the project focused on American students is more uncertain, because the invoice currency and currency denominating expenses are different. The project for students in Spain uses the same currency (euros) to generate revenue as the currency that it needs to cover expenses.
2022-03-21
Multinational Financial Management: An Overview