multinational fm2 2011-2012
TRANSCRIPT
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Chapter 19
MULTINATIONAL FINANCIAL
MANAGEMENT
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Multinational or Global Corporation
A firm that operates in an integrated fashion
in a number of (two or more) countries.
Decision making may be centralized in the
home country or decentralized across the
countries the corporation does business in.
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Reasons why companies expand into
other countries
To broaden their markets (Seek new markets)
To seek raw materials
To seek new technology
To seek production efficiency
Vertically IntegratedInvestment
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To avoid political, trade, and regulatory
hurdles
To diversify
To take advantage of specialized skills
To protect processes and products
To retain customers
Reasons why companies expand into
other countries
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Cost Migration Opportunities
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Regional trends in cost migration
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Going global
Becomes essential to effectively compete
especially with the advent of globalization
Used to be a competitive advantage before,
but now, it appears to be an inevitable move
especially for market leaders.
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Major factors that complicate financial
management in multinational firms
Different currency denominations
Economic and legal ramifications
Language differences Cultural differences
Role of governments
Political risks
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Monetary System
Local (National) Monetary System and Authority
Each nation has a monetary system and authority.
Task is to:
Hold down inflation
Promote economic growth (raise living standards)
For the US, the local monetary authority is the Federal
Reserve.
For the Philippines, the local monetary authority is the BSP.
International Monetary System
Must be in place for smoothen trade and facilitate payments
between nations
May be fixed or float
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International Monetary System
A system designed to facilitate payments betweennations when they are engaging in trade, thus, it is the
framework within which exchange rates are
determined.
It is the blueprint for international trade and capital
flows.
Regulated by intergovernmental agreements and driven
by each countrys unique political and economic
objectives.
Facilitates international trade, cross border investment
and the reallocation of capital between nations.
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International Monetary Terminology
Exchange Rate Spot exchange rate
Forward exchange rate
Fixed exchange rate Floating or flexible exchange rate
Devaluation of Currency
Revaluation of Currency
Depreciation of Currency
Appreciation of Currency
Applicable for Fixed
Currencies
Applicable for Floating
Currencies
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International Monetary System
End of WWII August 1971: Fixed exchange rate system (by
IMF)
Fixed exchange rate system
Also known as pegged exchange rate
A type of exchange rate regime wherein a currencys value ismatched to the value of another single currency or to a basket of
other currencies , or to another measure of value, such as gold.
Done by buying and selling own currency in the open market (have
huge foreign reserves) or making it illegal to trade currency at any
other rate (may lead to black market, however it may be successful
due to government monopolies over all money conversion)
Eg: China RMB (pegged to basket of currencies dollar, euro, Japanese yen,Korean won, Singapore dollar, sterling, Malaysian ringgit, Russian rouble,
Australian dollar, Thai baht and Canadian dollar.)
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International Monetary System
The current international monetary system is the FloatingExchange Rate System
Floating Exchange Rate System A system under which exchange rates are not fixed by government
policy but are allowed to float up or down in accordance with supply
and demand.
May cause exchange rate fluctuations and CB of each country needs
to intervene to smoothen out these fluctuations.
Results to Exchange Rate Risk
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Broad Groups of Currency Regimes: Floating Rates
Freely FloatingDetermined by supply and demand withoutsignificant government intervention.
Managed FloatingSignificant government intervention in themanipulation of the currencys supply and demand.
Fixed Rates
No local currencyNo local currency of its own and uses thecurrency of other countries. It surrenders the ability to use exchange
rate to tinker with its economy.
Currency board arrangementA country has local currencybut commits to exchange it for a specified foreign money unit at a
fixed exchange rate.
Fixed-peg arrangementA country locks its currency to aspecific currency or basket of currencies at a fixed exchange rate.
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Exchange Rates
Exchange rate the number of units of a given currencythat can be purchased for one unit of another currency
Direct Quotation Number of domestic currency
required to purchase one unit of foreign currency (FXY
expressed in DXY) eg: 1 Sgd = 32 Php
Indirect Quotation Number of units of foreign
currency that can be purchased for one unit of
domestic currency (DXY expressed in FXY) eg: 1 Php =0.03125 Sgd
Direct quotation is the reciprocal of indirect quotation.
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U.S. $ to buy1 Unit
Japanese yen 0.009
Australian dollar 0.650
Assuming that domestic country is the US, are these
currency prices direct or indirect quotations? Since they are prices of foreign currencies
expressed in dollars, they are direct quotations.
Consider the following exchange rates:
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Calculate the indirect quotations
for yen and Australian dollars.
# of Units of Foreign
Currency per U.S. $Japanese yen 111.11Australian dollar 1.5385
Yen: 1/0.009 = 111.11.A. Dollar: 1/0.650 = 1.5385.
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Sample Problems on Simple Exchange
Rates
If one Swiss franc can purchase $0.71 U.S.
dollar, how many Swiss francs can one U.S.
dollar buy?
If one U.S. dollar buys 1.0279 euros, how
many dollars can you purchase for one euro?
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Cross Rate (European Terms)
The exchange rate between any two
currencies.
They are actually calculated on the basis of
various currencies relative to the USD.
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Currency Cross Rates (American Terms) as
of Feb. 25, 2012Currencycodes /names
UnitedKingdomPound
CanadianDollar
EuroJapanese
YenSwissFranc
USDollar
PhilippinePeso
SingaporeDollar
GBP 1 0.6346 0.8488 0.007871 0.7043 0.6332 0.01483 0.5048
CAD1.5764 1 1.3379 0.012407 1.1101 0.9981 0.02338 0.7956
EUR 1.1784 0.7477 1 0.009274 0.8298 0.7461 0.01748 0.5948
JPY 127.077 80.6263 107.844 1 89.4842 80.4578 1.8844 64.1364
CHF 1.4203 0.9012 1.2053 0.011178 1 0.8993 0.02106 0.7169
USD 1.5794 1.0021 1.3404 0.01243 1.1122 1 0.02342 0.7971
PHP 67.7727 43.0003 57.5166 0.5334 47.7259 42.9104 1 34.2057
SGD 1.982 1.2575 1.682 0.0156 1.3957 1.2549 0.02939 1
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Cross rate = x
= 111.11 x 0.650= 72.22 yen/A. dollar.
Cross rate = x= 1.5385 x 0.009
= 0.0138 A. dollars/yen.
Calculate the two cross ratesbetween yen and Australian dollars.
Yen U.S. DollarsU.S. Dollar A. Dollar
A. Dollars U.S. Dollars
U.S. Dollar Yen
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The two cross rates are reciprocals of
one another.
They can be calculated by dividing either
the direct or indirect quotations.
Note:
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Sample Problems for Cross Exchange Rates
A currency trader observes the following quotes in the spot
market:
122 Japanese yen = 1 U.S. dollar
2.28 Swiss francs = 1 British pound
1 British pound = 1.6542 U.S. dollars
Given this information, what is the exchange rate between
the Swiss franc (SF) and the Japanese yen?
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Sample Problems for Cross Exchange Rates
Currently, in the spot market $1 = 106.45 Japanese yen, 1
Japanese yen = 0.00966 euro, and 1 euro = 9.0606 Mexican
pesos. What is the exchange rate between the U.S. dollar
and the Mexican peso?
Suppose exchange rates between U.S. dollars and Swissfrancs is SF 1.6564 = $1.00 and the exchange rate between
the U.S. dollar and the euro is $1.00 = 1.0279 euros. What
is the cross rate of the Swiss franc to the euro?
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Why is the USD the basis for cross rates?
Brettons Wood Agreement
Attempt to rebuild the international economic system after WW2
Done to regulate the international monetary system, BW planners
established IMF and IBRD (part of World Bank Group)
Each country should adopt a monetary policy that maintained the
exchange rate of its currency within a fixed value in terms of gold.
Gold was replaced by USD because there is inefficient supply of
gold (4.5 trillion) and there are also disadvantages and other
reasons (e.g. Soviet Union has a sizeable share of the worlds
known gold reserves, and it was later a Cold War Rival to US and
Western Europe)
The US Dollar acted as a store value as it was the strongest reserve
currency, and also it was pegged to gold.
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Recall:
1 USD = 111.11 JPY 1 JPY = 0.009 USD
1 USD = 1.5385 AUD 1 AUD = 0.65 USD
Using Cross Rate:
1 JPY = 0.01385 AUD
1 AUD = 72.2220 JPY
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Setting the appropriate price
A US firm can produce a liter of orange juiceand ship it to Japan for $1.75 per unit. If thefirm wants a 50% markup on the project, what
should the juice sell for in Japan?
Price = (1.75)(1.50)(111.11)
= 291.66 yen
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Determining profitability
The product will cost 250 yen to produce and ship to
Australia, where it can be sold for 6 Australian
dollars. What is the U.S. dollar profit on the sale?
Cost in A. dollars = 250 yen (0.0138)
= 3.45 A. dollars
A. dollar profit = 6 3.45 = 2.55 A. dollars
U.S. dollar profit = 2.55 / 1.5385 = $1.66 (or 2.55 x 0.65)
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Sample Problems Exchange rates and
Profitability The following exchange rates are quoted in the spot market:
$1 U.S. = 116.6 Japanese yen.
1 Canadian dollar = $0.66 U.S.
Crane Cola is a U.S. company with worldwide operations. The
company can produce a liter of cola in Canada at a cost of 0.45
Canadian dollars. The cola can be sold in Japan for 120 Japanese
yen. How much operating profit (measured in U.S. dollars) does
the company make on each liter of cola sold in the Japanese
market?
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Sample Problems Exchange rates and
Profitability Cypress Foods, a U.S. company, has a subsidiary that
produces lime juice in Brazil and sells it in Japan. The
exchange rates are such that 1 U.S. dollar equals 1.75
Brazilian real, and 1 U.S. dollar equals 120 Japanese yen.Cypress spends 1.2 real to produce one unit of lime juice
and sells it for 100 Japanese yen. What is the profit in U.S.
dollars realized from each unit of lime juice sold?
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What is exchange rate risk?
The risk that the value of a cash flow in one currencytranslated to another currency will decline due to a
change in exchange rates.
Risk inherent in a floating exchange rate system due
to exchange rate volatility.
This causes a companys consolidated cash flows to
fluctuate.
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Other Terms: Pegged Exchange Rate
Occurs when a country establishes a fixed exchange ratewith another major currency, consequently, values of
pegged currencies move together over time.
Usually done for smaller countries
Convertible Currency A currency that may be readily exchanged for other
currencies
A currency is convertible when the issuing country
promises to redeem the currency at current market rates
These are traded in world currency markets
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What problems may arise when a firm operates in
a country whose currency is not convertible?
It becomes very difficult for multi-national
companies to conduct business because there is
no easy way to take profits out of the country.
Often, firms will barter for goods to export to
their home countries. (e.g. the communist
countries during the cold war. Hyperinflation,e.g. in Germany after the two world wars.
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Trading in Foreign Exchange
Difference between spot rates and forwardexchange rates:
Spot Rates
The effective exchange rate for a foreign currency fordelivery on (approximately) the current day.
The rates to buy currency for immediate delivery.
Forward Rates
An agreed-upon price at which two currencies will beexchanged at some future date.
The rates to buy currency at some agreed-upon date in
the future.
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Discount / Premium on Forward Rate
Discount on Forward Rate (SLD, FGD)
When spot rate < forward rate
If the local currency (USD) buys more units of foreign
currency in the forward market than in the spot market
Forward less valuable than spotbecause it takes moreunits of a fxy to buy 1 USD in the future
Premium on Forward Rate (SGP, FLP)
When spot rate > forward rate
If the local currency (USD) buys more units of foreign
currency in the spot market than in the forward market
Forward more valuable than spotbecause it takes less
units of a fxy to buy 1 USD in the future
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Illustrative Problem:
Forward RatesSpot Rate 30 Days 60 Days 90 Days 180 Days
Philippine Peso 45.95 44.33 49.15 49.75 46.48
Which of the following statements is correct?a. There is a premium on the 30 day forward rate on the
Philippine peso.
b. There is a discount on the 60 day forward rate on the
Philippine peso.c. 1 USD is worth 44.93 Philippine pesos if traded
immediately.
d. All statements are correct.
e. None of the statements are correct.
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Interest Rate Parity
Aka International Fisher Effect
Specifies that investors should expect to earn the same returnin all countries after adjusting for risk.
A theory that the interest rate differential between two
countries is equal to the differential between the forward
exchange rate and the spot exchange rate.
countryforeigninrateinterestperiodick
countryhomeinrateinterestperiodick
rateexchangespotstoday'e
rateexchangeforwardperiod-tf
k1
k1
e
f
f
h
0
t
f
h
0
t
I R P i S l P bl
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Interest Rate Parity Sample Problems: In the spot market, 1 U.S. dollar can be exchanged for 121 Japanese yen.
In the 1-year forward market, 1 U.S. dollar can be exchanged for 125
Japanese yen. The 1-year, risk-free rate of interest is 5.2 percent in the
United States. If interest rate parity holds, what is the yield today on 1-
year, risk-free Japanese securities?
The nominal rate of interest on six-month, risk-free U.S. securities is 6
percent. Currently in the spot market, $1 U.S. = 104.84 Japanese yen. Inthe six-month forward market, $1 U.S. = 104.84 Japanese yen. If
interest rate parity holds, what is the current nominal interest rate on
six-month, risk-free Japanese securities?
90-day investments in Great Britain have a 6 percent annualized returnand a 1.5 percent quarterly (90-day) return. In the U.S., 90-day
investments of similar risk have a 4 percent annualized return and a 1
percent quarterly (90-day) return. In the 90-day forward market, 1
British pound () = $1.65. If interest rate parity holds, what is the spot
exchange rate?
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Discount / Premium on Currency
Currency is at Forward Premium
Domestic interest rate > Foreign interest rate
Currency is at Forward Discount
Domestic interest rate < Foreign interest rate
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Purchasing Power Parity
Aka Law of One Price
The relationship in which the same products cost roughly thesame amount in different countries after taking into account
the exchange rate.
It implies that the level of exchange rates adjusts so that
identical goods cost the same amount in different countries.
Ph = Pf(e0)
-OR-
e0
= Ph
/Pf
Ph = price of the good in the home country
Pf= price of the good in the foreign country
e0= todays spot exchange rate
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If grapefruit juice costs $2.00 per liter in the U.S.
and PPP holds, what is the price of grapefruit
juice in Australia?
e0 = Ph/Pf
$0.6500 = $2.00/PfPf = $2.00/$0.6500
= 3.0769 Australian dollars.
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Does PPP hold true?
Refer to Page 611 of your book The BIG MAC
INDEX or refer to the following slide:
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PPP Illustrative Problem:
For your 19th birthday, your parents decided to buy you a
Bugatti Veyron. This is a German-made car from German
manufacturer, the Volkswagen Group. They asked you to
canvass prices from different car dealers all over the world to
determine the best deal. After making several inquiries, you
have come up with a list below:
COUNTRY PRICE
USA USD 1,700,000
China Yuan 12,000,000Germany Euro 1,150,000
Japan Yen 140,000,000
Philippines Peso 80,000,000
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You have also come up with a cross rate list, as follows:
Requirement 1: Ignoring all other costs such as import duties,
taxes, shipping costs, and holding costs, and assuming that cross
rates hold true, how much is the percentage overvaluation or
undervaluation if you decide to buy the car in Japan? Requirement 2: Ignoring all other costs such as import duties,
taxes, shipping costs, and holding costs, and assuming that cross
rates hold true, in which country would you buy the car from in
order to get the best deal?
Currency
Codes/Names Euro
Japanese
Yen
US
Dollar
Chinese
Yuan
Philippine
Peso
EUR 1 0.007533 0.6891 0.1011 0.01512
JPY 132.775 1 91.4869 13.4192 2.0079
USD 1.4513 0.010932 1 0.1467 0.02195
CNY 9.9236 0.07475 6.8376 1 0.1501
PHP 66.5126 0.501 45.8287 6.7221 1
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PPP Short Problems:
A telephone costs $100 in the United States.
The same telephone costs 150 Canadian
dollars. Assume that purchasing power parity
holds. What is the exchange rate betweenU.S. and Canadian dollars?
A box of candy costs 28.80 Swiss francs (SF) in
Switzerland and $20 in the United States.Assuming that purchasing power parity (PPP)
holds, what is the current exchange rate?
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Inflation, Interest Rates, and Exchange Rates
What impact does relative inflation have on interest rates
and exchange rates? Currencies with higher inflation than the US depreciates over
time against the USD. Currencies with lower inflation than the
US appreciate against the USD.
Lower inflation leads the Fed to lower interest rates. Borrowing in low interest countries may appear attractive to
multinational firms. But, is it a good strategy?
As stated above, because currencies in low-inflation countriestend to appreciate against those in high-inflation rate countries,
so the effective interest cost increases over the life of the loan. Therefore, the lower interest rate could be more than offset by
losses from currency appreciation.
International Money and Capital Markets
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International Money and Capital Markets International Credit Markets
Eurocredits
Floating-rate bank loans that are available in most major trading currencies andthat are tied to LIBOR. They tend to be issued for a fixed term with no early
repayment.
EurodollarA source of dollars outside the US. USD deposited in a bank outside
US. Asian DollarUSD deposited in banks based in Asian countries.
International Bond Markets Foreign Bonds sold by foreign borrower, but denominated in the currency of
the country of issue. It is underwritten by investment banks from the same
country. (China sells bonds to Philippine companies and the bond is denominated
in RMB. Investment banks in China underwrites the bonds. These bonds are
from a different country). Eg: Yankee, Bulldogs, Samurai Bonds Eurobonds sold in the country other than the one in whose currency the bonds
are denominated. It is a bond issued in a currency other than the currency of the
country or market in which it is issued. It is underwritten by an international
syndicate. (China sells bonds to Philippine companies and the bond is
denominated in USD. An international syndicate underwrites the bonds. These
bonds are not sold in China).
l d l k
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International Money and Capital Markets
International Stock Markets
A Philippine firm may sell its stock in Japan to tap a larger
source of capital that the home country.
US firms may tap a foreign market to create an equity
market presence to accompany its operations in that
country.
Large multinational companies can issue new stock
simultaneously in multiple countries. This can create
arbitrage opportunities for investors.
American Depository Receipts (ADRs) certificates
representing ownership of foreign stock held in trust. They
are mostly traded on the OTC market but more are being
listed in stock exchanges.
Multinational Capital Budgeting
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Multinational Capital Budgeting Involves more complex cash flow estimation and analysis.
Involves repatriation of earnings (the process of sending CFs
from foreign subsidiary back to the parent company), though
foreign government may restrict it.
Foreign subsidiaries or branches cash flows are converted to
the parent companys currency. Must look at business climaterefers to a countrys social,
political, and economic environment.
Involves higher risk, particularly:
Country risk the risk that arises from investing or doing business in aparticular country.
Exchange rate risk the risk that relates to what the basic CFs will be
worth in the parent companys home currency.
Political risk potential actions by a host government that would reducethe value of a com an s investment.
Current risk score
C t S t C t C t E i P liti l St t l C dit ti D bt A t
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Current
rank
Sept
'10
Country name Current
score
Economic
(30%
weight)
Political
(30%
weight)
Structural
(10%
weight)
Credit rating
(out of 10,
10% wt)
Debt
indicators
(out of 10,
10% wt)
Access to
capital markets
(out of 10, 10%
wt)
1 1 Norway 93.44 90.40 92.97 84.10 10.00 10.00 10.002 6 Luxembourg 91.03 81.00 93.67 86.25 10.00 10.00 10.00
3 2 Switzerland 89.59 82.50 87.23 86.71 10.00 10.00 10.00
29 25 Korea South 72.28 65.75 67.86 69.13 7.29 10.00 8.00
39 60 Malaysia 64.75 60.80 60.63 65.40 6.25 8.04 7.50
40 36 China 63.55 66.88 48.47 52.41 7.71 8.73 7.25
42 45 Thailand 63.00 65.33 52.89 66.00 5.42 9.03 6.50
52 61 Indonesia 58.27 62.75 51.72 53.38 3.33 8.50 6.75
60 66 Sri Lanka 54.86 56.33 52.01 71.00 1.88 8.41 5.00
61 58 Philippines 54.46 52.67 50.08 57.50 2.92 8.23 6.75
62 102 Botswana 54.00 47.00 50.96 33.33 6.56 8.69 6.00
70 91 Bermuda 49.48 0.00 69.00 0.00 8.96 10.00 9.75
71 75 Vietnam 49.46 46.00 44.26 50.83 2.29 8.27 6.75
95 110 Nigeria 42.05 45.56 33.67 45.75 2.19 9.54 2.00
98 96 Belarus 39.84 43.75 34.38 27.81 1.88 8.73 3.00
99 101 Algeria 39.50 45.80 37.40 50.60 0.00 5.50 4.00
100 100 Mozambique 38.79 41.00 47.00 0.00 1.56 8.74 2.00
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International Capital Structure
Companies capital structures vary among
countries.
Problems when comparing capital structures
among nations:
Reporting assets on a historical cost versus a
replacement cost basis.
Treating leased assets Reporting pension plan liabilities
Capitalizing versus expensing R&D costs.
To what extent do average capital structures vary
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To what extent do average capital structures vary
across different countries? (Look at Page 621, Table
19-5)
Previous studies suggested that average capitalstructures vary among the large industrialcountries.
However, a recent study, which controlled fordifferences in accounting practices, suggeststhat capital structures are more similar across
different countries than previously thought.
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Impact of multinational operations
Cash management
Distances are greater.
Access to more markets for loans and for
temporary investments.
Cash is often denominated in different
currencies.
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Impact of multinational operations
Capital budgeting decisions
Foreign operations are taxed locally, and thenfunds repatriated may be subject to U.S. taxes.
Foreign projects are subject to political risk.
Funds repatriated must be converted to U.S.dollars, so exchange rate risk must be taken intoaccount.
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Impact of multinational operations
Credit management Credit is more important, because commerce to lesser-
developed countries often relies on credit.
Credit for future payment may be subject to exchange
rate risk. Inventory management
Inventory decisions can be more complex, especiallywhen inventory can be stored in locations in different
countries. Some factors to consider are shipping times, carrying
costs, taxes, import duties, and exchange rates.
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19-7: Currency Appreciation
Suppose that 1 Kong Kong dollar could be
purchased in the foreign exchange market
today for $0.1290. if the Hong Kong dollar
appreciated 10% tomorrow against the dollar,how many HKD would a US dollar buy
tomorrow?
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19-16: Foreign Investment Analysis
After all foreign and US taxes, a US corporation expects to
receive 3 Singapore dollars of dividends per share from a
Singaporean subsidiary this year. The exchange rate at the
end of the year is expected to be $0.7062 per SGD, and the
SGD is expected to depreciate 5% against the dollar each
year for an indefinite period. The dividend (in SGD) is
expected to grow at 10% a year indefinitely. The parent US
corporation owns 10 million shares of the subsidiary. Whatis the present value in dollars of its equity ownership of the
subsidiary? Assume a cost of equity capital of 15 percent
for the subsidiary.