ch 16 e 8 country risk analysis
TRANSCRIPT
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Chapter Objectives
To identify the common factors
used by MNCs to measure a countrys
polit ical risk and financial risk; To explain the techniques used to
measure country risk; and
To explain how MNCs use the assessmentof country risk when making f inancial
decisions.
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Why Country Risk Analysis Is Important
Country risk represents the potentiallyadverse impact of a countrys
environment on an MNCs cash flows.
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Country risk analysis can be used: to monitor countries where the MNC is
currently doing business;
as a screening device to avoid conducting
business in countries with excessive risk;
and
to revise its investment or financingdecisions in light of recent events.
Why Country Risk Analysis Is Important
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Political Risk Factors
Attitude of consumers in the host country Some consumers are very loyal to locally
manufactured products.
Actions of host governmentThe host government may impose special
requirements or taxes, restrict fund
transfers, and subsidize local firms. MNCscan also be hurt by a lack of restrictions,such as failure to enforce copyright laws.
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Political Risk Factors
Blockage of fund transfers If fund transfers are blocked, subsidiaries
will have to undertake projects that may
not be optimal for the MNC.
Currency inconvertibili tyThe MNC parent may need to exchange
earnings for goods if the foreign currencycannot be changed into other currencies.
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War Internal and external battles, or even the
threat of war, can have devastating effects.
Bureaucracy Bureaucracy can complicate businesses.
Corruption
Corruption can increase the cost of
conducting business or reduce revenue.
Political Risk Factors
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Corruption Index Ratings for Selected CountriesMaximum rating = 10. High ratings indicate low corrupt ion.
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Financial Risk Factors
Indicators of economic growthThe current and potential state of a
countrys economy is important since a
recession can severely reduce demand.
A countrys economic growth is dependent
on several financial factors - interest rates,
exchange rates, inflation, etc.
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Types of Country Risk Assessment
A macroassessment of country risk is anoverall risk assessment of a country
without considering the MNCs business.
A microassessment of country risk is therisk assessment of a country with respect
to the MNCs type of business.
The overall assessment thus consists ofmacropolitical risk, macrofinancial risk,
micropolitical risk, and microfinancial risk.
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Note that there is clearly a degree ofsubjectivity in:
identifying the relevant political andfinancial factors,
determining the relative importance of each
factor, and
predicting the values of factors that cannot
be measured objectively.
Types of Country Risk Assessment
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Techniques of
Assessing Country Risk The checklist approach involves rating
and weighting all the macro and micro
political and financial factors to derive anoverall assessment of country risk.
The Delphi technique involves collectingvarious independent opinions and then
averaging and measuring the dispersion
of those opinions.
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Techniques of
Assessing Country Risk Quantitative analysis techniques like
regression analysis can be applied to
historical data to assess the sensitivity ofthe business to various risk factors.
Inspection visits involve traveling to acountry and meeting with government
officials, firm executives, and consumers
to clarify uncertainties.
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Often, firms use a variety of techniques formaking country risk assessments.
For example, they may use the checklistapproach to develop an overall country
risk rating, and some of the other
techniques to assign ratings to the
factors.
Techniques of
Assessing Country Risk
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Measuring Country Risk
The checklist approach involves:
Assigning values and weights to political and
financial risk factors,
Multiplying the factor values with their
weights, and summing up to give the political
and financial risk ratings,
Assigning weights to the risk ratings, andMultiplying the ratings with their weights, and
summing up to give the country risk rating.
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Cougar Co.:Determining the Overall Country Risk Rating
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Cougar Co.:Derivation of the Overall Country Risk Rating
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Comparing Risk Ratings
Among Countries One approach to comparing political and
financial ratings among countries is the
foreign investment risk matrix (FIRM).
The matrix displays financial (oreconomic) and political risk by intervals
ranging from poor to good.
Each country can be positioned on thematrix based on its polit ical and f inancial
ratings.
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Actual Country Risk Ratings Across Countries
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Incorporating Country Risk in
Capital Budgeting If the risk rating of a country is acceptable,
the projects related to that country
deserve further consideration. Country risk can be incorporated into the
capital budgeting analysis of a proposed
project either by adjusting the discount
rate or by adjusting the estimated cash
flows.
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Adjustment of the discount rateThe higher the perceived risk, the higher
the discount rate that should be applied to
the projects cash flows.
Adjustment of the estimated cash flows By estimating how the cash flows could be
affected by each form of risk, the MNC can
determine the probability distribution of the
net present value of the project.
Incorporating Country Risk in
Capital Budgeting
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Spartan, Inc.: Summary of Estimated NPVsAcross Possible Scenarios
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Applications of
Country Risk AnalysisAs a result of the crisis that culminated in
the Gulf War in 1991, many MNCs
reassessed their exposure to country riskand revised their operations accordingly.
The 199798 Asian crisis caused MNCs torealize that they had underestimated the
potential financial problems that could
occur in the high-growth Asian countries.
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Following the September 11, 2001 attackon the United States, some MNCs reduced
their exposure to country risk bydownsizing or discontinuing their
business in countries where U.S. firms
may be subject to more terrorist attacks.
Applications of
Country Risk Analysis
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Reducing Exposure
to Host Government Takeovers The potential benefits of DFI can be offset
by country risk, the most severe of which
is a host government takeover. To reduce the chance of a takeover by the
host government, firms often:
Use a short-term horizonThis technique concentrates on recovering
cash flow quickly.
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Reducing Exposure
to Host Government TakeoversRely on unique supplies or technology
In this way, the host government will not be
able to take over and operate thesubsidiary successfully.
Hire local labor
The local employees can apply pressure
on their government if they are affected by
the takeover.
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Use project finance
Project finance deals are heavily financed
with credit, thus limiting the MNCsexposure. The loans are secured by the
projects future revenues and are
nonrecourse. A bank may guarantee the
payments to the MNC.
Reducing Exposure
to Host Government Takeovers