International

Financial Management
1
Jeff Madura
10
th
Edition

Prepared By: Hamad Raza (Lecturer GCUF)

Chapter 1:
Multinational Financial Management:
An Overview
What is Finance?
2
Finance can be defined as the art and science of
managing the money.
Finance is concerned with the process,
institutions, markets, and instruments involved in
the transfer of money among individuals,
businesses, and governments.
DEFINITION OF INTERNATIONAL FINANCE
3
International finance is the branch of economics
that studies the dynamics of foreign exchange
(where money in one currency is exchanged for
another), foreign direct investment (Foreign
direct investment (FDI) is investment directly
into production in a country by a company located
in another country,) and how these affect
international trade.
It also includes the study of international projects,
international investments and the international
capital flows.
International Finance can be broadly defined, as
the study of the financial decisions taken by a
multinational corporation in the area of
international business i.e. global corporate
finance.

DEFINITION OF INTERNATIONAL FINANCE
MANAGEMENT
4
International Financial Management is a
managerial activity which is concerned with the
planning and controlling of financial resources of
a firm involved in international business.


REASONS TO STUDY INTERNATIONAL FINANCE
MANAGEMENT
5
To understand the global economy
To understand the effect of Global Finance on
business
Global finance has become increasingly important
as it serves world trade and foreign investment.
To make intelligent decisions
CLASSIFICATION OF INTERNATIONAL BUSINESS
OPERATIONS
6
The international business firms are broadly divided
into three categories:
(a) International Firm
(b) Multinational firm
(c) Transnational Firm
(a) International Firm
The traditional activity of an international firm involves importing
and exporting. Goods are produced in the domestic market and
then exported to foreign buyers.
Financial management problems of this basic international trade
activity focus on the payment process between the foreign buyer
(seller) and domestic seller (buyer).

CLASSIFICATION OF INTERNATIONAL BUSINESS
OPERATIONS
7
(b) Multinational firm
As international business expands, the firm needs to be closer to the
consumer, closer to cheaper sources of inputs, or closer to other
producers of the same product gain from their activities. It needs to
produce abroad as well as sell abroad.
As the domestic firm expands its operations across borders,
incorporating activities in other countries, it is classified as a
multinational firm.
(c)Transnational Firm
As the multinational firm expands its branches, affiliates, subsidiaries,
and network of suppliers, consumers, distributors and all others, which
fall under the firm umbrella of activities, the once traditional home
country becomes less and less well defined.
Firms like Unilever, Phillips, Ford, and Sony have become intricate
network with home offices defined differently for products, processes,
capitalization and even taxation.
Multinational Corporations
8
Multinational corporations (MNCs) are defined as
firms that engage in some form of international
business.
Their managers conduct international financial
management, which involves international
investing and financing decisions those are
intended to maximize the value of the MNC.
The goal of their managers is to maximize the
value of the firm, which is similar to the goal of
managers employed by domestic companies.
Goal of the MNC
9
The commonly accepted goal of an MNC is to
maximize shareholders wealth.
This book is focused on MNCs those are based in
the United States and wholly own their foreign
subsidiaries.

Conflicts Against the MNC Goal
10
For corporations with shareholders who differ
from their managers, a conflict of goals can exist -
the agency problem.
Agency costs are normally larger for MNCs than
for purely domestic firms.
The scattering of distant subsidiaries.
The sheer size of the MNC.
The culture of foreign managers.
Subsidiary value versus overall MNC value.

Impact of Management Control
11
The magnitude of agency costs can vary with the
management style of the MNC.
A centralized management style reduces agency
costs. However, a decentralized style gives more
control to those managers who are closer to the
subsidiarys operations and environment.

Centralized Multinational Financial
Management
12
For a MNC with two subsidiaries, A and B
Financial
Managers
of Parent
Capital Expenditures
at A
Inventory and
Accounts
Receivable
Management at A
Cash
Management
at A
Financing at A
Capital Expenditures
at B
Inventory and
Accounts
Receivable
Management at B
Cash
Management
at B
Financing at B
Decentralized Multinational Financial
Management
13
For a MNC with two subsidiaries, A and B
Financial
Managers
of A
Capital Expenditures
at A
Inventory and
Accounts
Receivable
Management at A
Cash
Management
at A
Financing at A
Capital Expenditures
at B
Inventory and
Accounts
Receivable
Management at B
Cash
Management
at B
Financing at B
Financial
Managers
of B
Corporate Control of Agency Problem
14
Various forms of corporate control can reduce
agency costs & therefore ensure that managers
make decisions to satisfy the MNCs
shareholders.
Some MNCs attempt to strike a balance - they
allow subsidiary managers to make the key
decisions for their respective operations, but the
decisions are monitored by the parents
management.
Electronic networks make it easier for the parent
to monitor the actions and performance of foreign
subsidiaries.
For example, corporate intranet or internet email
facilitates communication. Financial reports and
other documents can be sent electronically too.

Constraints
Interfering with the MNCs Goal
15
As MNC managers attempt to maximize their
firms value, they may be confronted with various
constraints.
Environmental constraints.
Regulatory constraints.
Ethical constraints.

Theories of International Business
16
Why are firms motivated to expand their
business internationally?
Theory of Comparative Advantage:
Specialization by countries can increase production
efficiency.
Imperfect Markets Theory:
The markets for the various resources used in
production are imperfect.
Product Cycle Theory:
As a firm matures, it may recognize additional
opportunities outside its home country.

Firm exports
product to
accommodate
foreign demand.
Firm creates
product to
accommodate
local demand.
The International Product Life Cycle
Firm
establishes
foreign
subsidiary to
establish
presence in
foreign
country and
possibly to
reduce costs.
a. Firm
differentiates
product from
competitors and/or
expands product
line in foreign
country.
b. Firms
foreign business
declines as its
competitive
advantages are
eliminated.
or
17
International
Business Methods
International trade is a relatively conservative
approach involving exporting and/or importing.
The internet facilitates international trade by
enabling firms to advertise and manage orders
through their websites.
There are several methods by which firms can
conduct international business.
18
International
Business Methods
Licensing allows a firm to provide its technology
in exchange for fees or some other benefits.
Franchising obligates a firm to provide a
specialized sales or service strategy, support
assistance, and possibly an initial investment in
the franchise in exchange for periodic fees.
19
International
Business Methods
Firms may also penetrate foreign markets by
engaging in a joint venture (joint ownership and
operation) with firms that reside in those markets.
Acquisitions of existing operations in foreign
countries allow firms to quickly gain control over
foreign operations as well as a share of the
foreign market.
20
International
Business Methods
Firms can also penetrate foreign markets by
establishing new foreign subsidiaries.
In general, any method of conducting business
that requires a direct investment in foreign
operations is referred to as a direct foreign
investment (DFI).
The optimal international business method may
depend on the characteristics of the MNC.
21
Degree of International Business by
MNCs
26%
62%
58%
33%
47%
12%
46%
40%
50%
66%
0%
10%
20%
30%
40%
50%
60%
70%
Campbell's Soup IBM Nike
Foreign Sales as a % of Total Sales
Foreign Assets as a % of Total Assets
22
International Opportunities
Investment opportunities - The marginal return on
projects for an MNC is above that of a purely
domestic firm because of the expanded
opportunity set of possible projects from which to
select.
Financing opportunities - An MNC is also able to
obtain capital funding at a lower cost due to its
larger opportunity set of funding sources around
the world.
23
Marginal
Return on
Projects
Purely
Domestic
Firm
MNC
Asset Level
of Firm
Investment
Opportunities
International Opportunities
Cost-benefit Evaluation for
Purely Domestic Firms versus MNCs
Appropriate Size
for Purely
Domestic Firm
Appropriate Size
for MNC
X Y
Marginal
Cost of
Capital
Purely
Domestic
Firm
MNC
Financing
Opportunities
24
Exposure to International Risk
exchange rate movements
Exchange rate fluctuations affect cash flows and
foreign demand.
foreign economies
Economic conditions affect demand.
political risk
Political actions affect cash flows.
International business usually increases an MNCs
exposure to:
25
Managing for Value
Like domestic projects, foreign projects involve an
investment decision and a financing decision.
When managers make multinational finance
decisions that maximize the overall present value
of future cash flows, they maximize the firms
value, and hence shareholder wealth.
26
( )
( )

+
n
t
t
t
k
1 =
$,
1
CF E
= Value
E (CF
$,t
) = expected cash flows to be received at the end
of period t
n = the number of periods into the future in
which cash flows are received
k = the required rate of return by investors
Valuation Model for an MNC
Domestic Model
27
( ) ( ) | |
( )

=
n
t
t
m
j
t j t j
k
1 =
1
, ,
1
ER E CF E
= Value
E (CF
j,t
) = expected cash flows denominated in currency j to be
received by the U.S. parent at the end of period t
E (ER
j,t
) = expected exchange rate at which currency j can be
converted to dollars at the end of period t
k = the weighted average cost of capital of the U.S. parent
company
Valuation Model for an MNC
Valuing International Cash Flows
28
Valuation Model for an MNC
An MNCs financial decisions include how much
business to conduct in each country and how
much financing to obtain in each currency.
Its financial decisions determine its exposure to
the international environment.
29
Valuation Model for an MNC
Impact of New International Opportunities
on an MNCs Value
Exchange Rate Risk
( ) ( ) | |
( )

=
n
t
t
m
j
t j t j
k
1 =
1
, ,
1
ER E CF E
= Value
Political Risk
Exposure to
Foreign Economies
30
How Chapters Relate to Valuation
Background
on
International
Financial
Markets
(Chapters
2-5)
Exchange Rate
Behavior
(Chapters 6-8)
Long-Term
Investment and
Financing
Decisions
(Chapters 13-18)
Short-Term
Investment and
Financing
Decisions
(Chapters 19-21)
Exchange Rate Risk
Management
(Chapters 9-12)
Risk and
Return of
MNC
Value and
Stock Price
of MNC
31
Chapter Review
Goal of the MNC
Conflicts Against the MNC Goal
Impact of Management Control
Impact of Corporate Control
Constraints Interfering with the MNCs Goal
Theories of International Business
Theory of Comparative Advantage
Imperfect Markets Theory
Product Cycle Theory
32
Chapter Review
International Business Methods:
International Trade
Licensing
Franchising
Joint Ventures
Acquisitions of Existing Operations
Establishing New Foreign Subsidiaries
33
Chapter Review
Exposure to International Risk
Exposure to Exchange Rate Movements
Exposure to Foreign Economies
Exposure to Political Risk
Managing for Value
34
Chapter Review
Valuation Model for an MNC
Domestic Model
Valuing International Cash Flows
Impact of Financial Management and International
Conditions on Value
How Chapters Relate to Valuation
35