Financial Management subject For undergraduate students (semester 4)

1. International financial
management
Meeting 11

2. • 1. entering foreign markets
• 2. international investment decisions
• 3. exchange rates

3. Multinational companies (MNCs)
• Many companies now operate internationally, either through
exporting goods and services or through setting up operations in
foreign countries.
• This has significant implications for corporate financing and
investment decisions.
• Investing directly in a foreign country raises questions about the
source and currency of financing.
• The primary goal in evaluating both international and domestic
investment proposals is to check how proposed investment will lead
to an increase in the wealth of shareholders.

4. Evaluation of international investment proposals is
more complex than the evaluation of domestic
ones
• Exchange rates will need to be forecast and the effect on project cash
flows of different taxation systems will need to be considered. The
risk arising from the actions and decisions of foreign governments
must also be assessed.
• A company could undertake international operations through
licensing, franchising or setting up a foreign branch rather than by
investing directly in a foreign subsidiary. This is especially true in the
early stages of becoming an international company.

6. Direct Export
• Def.: Direct exporting is the most common
strategy. It’s simple – you sell directly to the
market that you’re trying to break into.
• E.g.: The Austrian energy drink Red Bull entered
Australia using direct export as its entry mode. Red
Bull is the leading energy drink brand in the
Australian market, holding a 36% market share.
This case of Red Bull supports that exporting can
be a very successful foreign entry mode strategy.
• US chewing gum company Wrigley successfully
entered the Indian market using cooperative
export as their foreign entry mode

7. Licensing
• Def.: You talk to foreign firms and ask them to
temporarily own the product. You first have to convince
the firm that your product is right for them and it will
sell. Then, you need to deal with governments for the
legal aspects of the “sale” of the license. You don’t lose
control of your product. You’re licensing the rights to
your product to a foreign company for a limited amount
of time.
• E.g.: Microsoft Corp and Walt Disney Co are two
examples of large multinationals that have had success
in foreign markets using licensing as their entry mode
• Eg. Pepsico, Coke

8. Franchising
• Def: Involves the organization (franchiser) providing
branding, concepts, expertise, to the franchisee.
• E.g.: Hilton began franchising its hotels in 1965 and
currently 36% of company revenues are franchise fees.
• The franchisees pay Hilton an initial fee based on the
number of rooms and a continuing fee based on
revenues.
• Hilton is involved in the approval of plans for and the
location of the franchised hotels and also assists in the
design
• Eg. McDonalds, Subway, KFC

9. Mergers and Acquisitions -
M&A
• Def.: M&A are transactions in which the
ownership of companies or their operating
units are transferred or combined.
• E.g. Coca Cola acquired the worlwide beverage
interests of Cudbury Schweppes and all
related brands in about 155 countries

10. Joint venturing
• Def.: A new company is set up with parties owning a
proportion of the new business.
• Companies set up Joint Ventures to assist them to enter a
new international market: access to technology, core
competences or management skills, distribution channels,
manufacturing and R&D.
• E.g.: AutoAlliance International (AAI) is a joint venture
automobile assembly firm co-owned by Ford and Mazda.
AAI produced some of the Mazda 626, Mazda MX-6 and
Ford Probe (all related) sold in America since 1990.
• Sony-Ericsson is a joint venture by the Japanese consumer
electronics company Sony Corporation and the Swedish
telecommunications company Ericsson to make mobile
phones

11. Greenfield Investments
• Def.: It is the establishment of a new wholly owned
subsidiary. It is often complex and potentially costly, but
it is able to provide full control to the firm and has the
most potential to provide above average return.
• E.g.: Chevron through their wholly owned subsidiary PT
Chevron Pacific Indonesia, they become the largest
producer of Indonesia’s crude oil.
• Mercedes Benz began its Indian production in the mid-
1990s from a plant based in the small town of Pimpri. In
2007 it acquired 100 acres for a greenfield plant in
Pune, India. The production capacity could now turn
out almost 5000 vehicles

12. Foreign Direct Investment
(FDI)
• Def.: The objective of a resident entity in one
economy obtaining a lasting interest in an
enterprise resident in another economy. FDI
normally involves some degree of equity
ownership on the part of the foreign investor.
• E.g. Honda began producing the Dream
motorcycle in Vietnam in 1997 in order to
serve the Vietnamese market—a form of
international production

15. The internationalisation strategy of Toyota
• Began by establishing subsidiaries to export cars in key markets in the
1970ʼs
• Faced difficulties in Europe due to import restrictions and could not
establish direct presence due to restrictions of direct investment by
Japanese firms
• Began to manufacture forklifts under licence in 1987 and then established
a joint-venture with its licensee in 1996.
• Localised production in Europe in 1998 by setting up an assembly plant in
Valenciennes (France) taking advantage of high unemployment in the area
and, of tax incentives offered by the French government.
• In 1999, the EU lifted restrictions on Japanese car imports and Toyota
began to export compact cars into Europe.

16. 4 lessons learned from famous market entry
successes
• 1. Starbucks in China
• 2. McDonald’s in France
• 3. IKEA in China
• 4. Red Bull in America
• Original article: http://www.tradeready.ca/2015/trade-takeaways/4-
lessons-learned-famous-market-entry-successes/

17. The evaluation of foreign investment
decisions
• Foreign direct investment is a long-term investment in an economy
other than that of the investing company, where the investing
company has control over the business invested in.
• The main example of such an investment is the setting up or
purchase of a foreign subsidiary

18. Features of FDI
• International investment decisions have some distinctive features
which make their evaluation more difficult:
•
- project cash flows will need to be evaluated in a foreign currency;
- exchange rate movements create currency risk, which may need
hedging;
- foreign taxation systems may differ from the domestic taxation
system;
- project cash flows will be different;
- remittance of project cash flows may be restricted;
- the investment may be subject to political risk

19. FDI evaluation:
NPV – DCF – IRR
• FDI decisions are not different from domestic investment decisions
• Can be evaluated using the same investment appraisal techniques,
such as the net present value method (NPV)
• Companies can use discounted cash flow (DCF) methods of
investment appraisal for evaluating foreign investment projects, with
internal rate of return (IRR) being preferred to net present value

20. DCF vs NPV
• DCF is the sum of all future cash flows of a given project or business or
whatever, discounted to present day (because money in the future is
worth less than it is today...e.g. $100 a year from now is only worth $95).
Basically this tells me, "So this business is generating $$ per year for 10
years, what is all of that $$ cash flow, over 10 years, worth to me TODAY?“
• NPV is calculated using the DCF and subtracts the cost of the investment.
Basically, it tells me, "If I have to spend $$ TODAY to generate all this
future cash flow, am I getting more OR less than what I paid?" If' the NPV
is negative, then effectively I would be giving away money. If it is positive,
then I would be getting back SOMETHING for making the investment over
that time period.

21. Foreign exchange market
• The foreign exchange market is the world’s largest financial market.
• It is the market where one country’s currency is traded for another’s.
Most of the trading takes place in a few currencies:
• the U.S. dollar ($)
• the British pound sterling (£)
• the Japanese yen (¥)
• and the euro (€)

22. Participants in the foreign exchange market
• 1. Importers who pay for goods using foreign currencies.
• 2. Exporters who receive foreign currency and may want to convert to
the domestic currency.
• 3. Portfolio managers who buy or sell foreign stocks and bonds.
• 4. Foreign exchange brokers who match buy and sell orders.
• 5. Traders who “make a market” in foreign currencies.
• 6. Speculators who try to profit from changes in exchange rates.

23. EXCHANGE RATES
• An exchange rate is simply the price of one country’s currency
expressed in terms of another country’s currency
• In practice, almost all trading of currencies takes place in terms
of the U.S. dollar. For example, both the Swiss franc and the Japanese
yen are traded with their prices quoted in U.S. dollars
• Exchange rates are constantly changing

24. Indirect aka inverse exchange rate
• This is the amount of foreign currency per U.S. dollar.
• Naturally this second exchange rate is just the reciprocal of the first
• one (possibly with a little rounding error)

35. Types of Transactions
• There are two basic types of trades in the foreign exchange market: Spot trades
and forward trades.
• A spot trade is an agreement to exchange currency “on the spot,” which actually
means that the transaction will be completed or settled within two business days.
The exchange rate on a spot trade is called the spot exchange rate.
•
A forward trade is an agreement to exchange currency at some time in the
future.
• The exchange rate that will be used is agreed upon today and is called the
forward exchange rate. A forward trade will normally be settled sometime in the
next 12 months.

36. A New Zealand traveler returned from Singapore
with SGD7,500 (Singapore dollars). A foreign
exchange dealer provided the traveler with the
following quotes:
• Ratio Spot Rates
• USD/SGD 1.2600
• NZD/USD 0.7670
• USD: US dollar
• NZD: New Zealand dollar
• What is the amount of New Zealand dollars (NZD) that the traveler
would receive for his Singapore dollars?

37. 7,248
• The NZD/SGD cross-rate is NZD/USD × USD/SGD = 0.7670 × 1.26 =
0.9664
• The traveler will receive: 0.9664 NZD per SGD; 0.9664 NZD/SGD ×
7,500 SGD = 7,248 NZD

38. Cross-Exchange Rate
• Given the exchange rate between currencies A and B and currencies B
and G, you can derive the exchange rate between currencies A and G.
• In general,
• S (A/G) = S (A/B) x S (B/G)
• Note that S (A/G) represents the spot rate (say, the average of the bid
and ask prices) between currencies A and G, and so on.

39. Example:
• S (INR/USD) = 0.0226
• S (USD/CHF) = 1.2381
• Given the above rates you can calculate the exchange rate between
INR and CHF.
• S (INR/CHF) = S (INR/USD) x S (USD/CHF)
• = 0.0226 x 1.2381 = 0.0280
• Most commonly, cross-rate calculations are done to establish the
exchange rates between two currencies that are quoted against the
US dollar but are not quoted against each other.

40. Big Mac PPP (index)
• is calculated by examining the price of a Big Mac in a given country in
its home currency and divides it by the price of a U.S. Big Mac.
• Let's say that we are looking at the Big Mac in China.
• If a Chinese Big Mac is 10.41 renminbi (RMB) and the U.S. price is
$2.90, then — according to PPP — the exchange rate should be 3.59
RMB for US$1. (10.41/2.90)
• However, if the RMB were actually trading in the currency market at
8.27 RMB for US$1, the Big Mac PPP would suggest that the RMB is
undervalued.