Chapter 16 International Financial Management

Slide 16.
Chapter 16
International financial management
Rugman and Collinson, International Business, 6th Edition, Pearson Education Limited 2013
Slide 16.2
International financial management
Objectives
Introduction
Determining parentsubsidiary relationships
Managing global cash flows
Exchange risk management
Capital budgeting in the MNE
International financing in the MNE
Control: Identifying objectives, evaluating affiliate
performance and making performance consistent with
goals.
Slide 16.3
Objectives
Compare and contrast how polycentric, ethnocentric and
geocentric solutions are used in determining the financial
planning and controlling authority that is given to subsidiaries.
Study some of the most common techniques that are used in
managing global cash flows, including funds positioning and
multilateral netting.
Examine foreign exchange risk strategies that are used to
protect the multinational against transaction, translation and
economic exchange risks.
Explain how capital budgeting is carried out in a multinational
firm.
Describe how international financing opportunities for an MNE
differ from those available to a domestic firm.
Provide examples of international financial strategies currently
being used by multinationals.
Slide 16.4
Introduction
International financial management encompasses a
number of key areas. These include:
the management of global cash flows;
foreign exchange risk management;
capital expenditure analysis and capital budgeting.
The objective of international financial management

strategies is to provide assistance to all geographic
operations and to limit financial losses through:
the use of carefully formulated cash flow guidelines;
the timely execution of foreign exchange risk
management strategies;
prudent capital expenditures;
careful capital budgeting.
Slide 16.5
Financial management
Basic financial management can be divided into
two broad headings:
choice and management of sources of funds;
choice and management of uses of funds.
At the international level, exchange risk

management must be added.
Slide 16.6
Figure 16.1
Financial management in the MNE

Slide 16.7
Determining parentsubsidiary
relationships
Slide 16.8
Three managerial solutions

Polycentric solution: it involves treating the
MNE as a holding company and decentralizing
decision making to the subsidiary levels.
Ethnocentric solution: it involves treating all
foreign operations as if they were extensions of
domestic operations.
Geocentric solution: it involves handling
financial planning and controlling decisions on a
global basis.
Slide 16.9
Managing global cash flows
Slide 16.10
Internal funds flows

Internal flow of funds
Working capital: the difference between current
assets and current liabilities.
Borrowing from a local bank or from the parent
company.
Having the parent company increase its equity
capital investment in the subsidiary.
Slide 16.11
Figure 16.2
Common examples of internal sources and flows of funds

Slide 16.12
Funds positioning techniques

Funds positioning techniques: strategies used
to move monies from one multinational operation
to another.
Transfer price: an internal price set by a company
in intrafirm trade such as the price at which one
subsidiary will sell a product to another subsidiary.
Cf. Arms length price: the price a buyer will pay for
merchandise in a market under conditions of perfect
competition.
Tax havens: low-tax countries that are hospitable

to business.
Fronting loans: a funds positioning strategy that
involves having a third party manage the loan.
Slide 16.13
Table 16.1
Shifting profits by transfer pricing

Slide 16.14
Table 16.2
Transfer pricing through tax havens

Slide 16.15
Multilateral netting
Multilateral netting: the process of determining
the net amount of money owed to subsidiaries
through multilateral transactions.
Slide 16.16
Table 16.3
Net cash positions of subsidiaries

Slide 16.17
Figure 16.3
Multilateral dollar flows between subsidiaries

Slide 16.18
Figure 16.4
Centralized netting process in action

Slide 16.19
Managing cash
Viewing the company as a single unit for
purposes of cash management can yield far
better results than would be obtained if each
affiliate managed its cash independently.
For example, much less foreign exchange
protection is generally needed if all of the affiliates
are evaluated together than if each affiliate hedges
its own position.
Slide 16.20
Potential gains to the MNE

from centralized cash management
1. By pooling the cash holdings of affiliates, the MNE can
hold a larger total amount of cash, thus reducing its
financing needs.
2. It can have one group of people specialize in the
performance of centralizing cash management task, thus
achieving better decisions and economies of scale.
3. By reducing the amount of cash in any one affiliate, it can
reduce country risks as well as financial costs.
4. It can net out intracompany accounts when there are
multiple payables and receivables among affiliates, thus
reducing the amount of money actually transferred among
affiliates.
5. Its central cash management group can ensure that cash
management decisions aim at corporate goals rather than
the goals of individual affiliates when these might conflict.
Slide 16.21
Exchange risk management
Slide 16.22
Three types of exchange risk

Three kinds of exchange risk should be
differentiated:
Transaction risk: the risk of an unexpected

change in the home-currency value during the time
of maturity.
For example, accounts payable and receivable, loans

and bank deposits denominated in foreign
currencies.
Translation risk: the risk of value changes in

foreign currency assets and liabilities on the
balance sheet, whether or not the transactions
occur during the accounting period.
For example, the plant and equipment of foreign
subsidiaries.
Economic risk: the risk of unexpected changes in

future cash flows from foreign operations.
Slide 16.23
Table 16.4
Exchange risk hedging techniques*
* These techniques assume no expectation about the direction of exchange rate change. If devaluation is expected, then creation of a net liability
position is attractive and vice versa for expected revaluation.
In each instance, the hedge must produce an equal-value asset (liability) in the same currency with equal maturity to offset the exposed liability (asset)
Slide 16.24
Developing forecasting and reporting systems

Decide the types and degrees of economic exposure that
the company is willing to accept.
Develop the necessary expertise for monitoring exchange
rates and for forecasting those rates that are applicable to
the identified exposures.
Construct a reporting system that allows the firm to
identify exposed accounts, to measure this exposure and
to feed back information on what the firm is doing and the
status of these decisions.
Include all MNE units in this reporting system so that each
better understands the risks it is assuming and is aware of
the actions that must be taken to deal with these risks.
Keep senior-level management fully apprised of what is
going on in each area of responsibility so that every
manager is able to periodically revise the exposure risk.
Slide 16.25
Capital budgeting in the MNE
Slide 16.26
Expenditures
Capital expenditures: Major projects for which
the costs are to be allocated over a number of
years
For example, major acquisitions, the building of
new plants and the refurbishing of existing
equipment.
Slide 16.27
Risks in international
capital investments
Types of risk the MNE faces when undertaking
international capital investments.
Exchange risk
Affects the US dollar value of the profits earned,
potentially raising or lowering them substantially.
Country risk
For example, currency inconvertibility, corporate
taxes and investment laws.
Borrowing risk
Country-dependent.
Slide 16.28
Net Present Value (NPV)

Because the firm has to live with the results of
these decisions for a long period of time,
mathematical techniques of analysis are often
used, including discounted cash flow techniques.
Slide 16.29
Net Present Value (NPV) (Continued)
where,
It = investment cash outlays in year t

Ct = cash inflows in year t
T = terminal date or end of project
KA = weighted average cost of capital
ke = cost of equity capital
kd = cost of debt financing
tx = tax rate
D/V, S/ V = debt and equity ratios,
respectively
NPV = incremental net present
value for the project.
Slide 16.30
Institutional features
Government subsidies and controls
Foreign investment review agencies in Australia
and Canada.
Political risk insurance
Slide 16.31
International financing in the MNE
Slide 16.32
Table 16.5
International sources of credit (including markets and intrafirm transfers)
Note: Direct means borrowing from owners of wealth (e.g. investors); intermediated means borrowing from a financial intermediary (e.g. a bank).
International back-to-back loan means a loan in which two companies in different countries borrow offsetting amounts from one another in each others
currency
Slide 16.33
Financial structure
Debt-equity ratio: the value of a firms total debt
divided by the value of its total equity. A higher
ratio implies greater leverage and potentially
greater risk.
The normal debt/equity ratio differs from industry
to industry and from country to country.
Since the MNE is evaluated by investors in the
home country, its overall debt/equity structure
must satisfy the financial community in that
country.
If the firm sells shares of an affiliate in the host
countrys financial market, the debt/equity position
of the affiliate is an important issue.
Slide 16.34
Reasons for local borrowing

If funding is available at low cost (adjusted for
expected exchange rate changes).
If a substantial amount of assets is exposed
locally, local borrowing provides a hedge to both
exchange and country risks.
If the local currency is expected to devalue
substantially, then, even if local interest rates are
high, it may make sense to borrow locally,
assuming the expected postdevaluation interest
costs would be lower than the home country
costs.
Slide 16.35
Other issues regarding

financial structure
Local equity financing may be forced on the firm if
the host government demands partial local
ownership of foreign enterprises.
Reinvestment of funds that face repatriation
restrictions.
Slide 16.36
Control
Slide 16.37
Control
Control is the fundamental function of
management that involves developing profit plans
for the firm and its divisions and then deciding
what to do when actual operating results differ
from those planned.
Evaluating the performance of managers of
foreign affiliates must take into consideration
exchange risk and the constraints placed upon
the subsidiary.

Chapter 16 International Financial Management

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Slide 16.

International financial management

International financial management

The objective of international financial management

At the international level, exchange risk

Financial management in the MNE

Three managerial solutions

Managing global cash flows

Internal funds flows

Common examples of internal sources and flows of funds

Funds positioning techniques

Tax havens: low-tax countries that are hospitable

Shifting profits by transfer pricing

Transfer pricing through tax havens

Net cash positions of subsidiaries

Multilateral dollar flows between subsidiaries

Centralized netting process in action

Potential gains to the MNE

Exchange risk management

Three types of exchange risk

Transaction risk: the risk of an unexpected

For example, accounts payable and receivable, loans

Translation risk: the risk of value changes in

Economic risk: the risk of unexpected changes in

Exchange risk hedging techniques*

Developing forecasting and reporting systems

Capital budgeting in the MNE

Net Present Value (NPV)

Net Present Value (NPV) (Continued)

It = investment cash outlays in year t

Political risk insurance

International financing in the MNE

International sources of credit (including markets and intrafirm transfers)

Reasons for local borrowing

Other issues regarding

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