Type:
Solution Manual
Foundations of Multinational Resource: Financial Management Edition:
6th Edition
Author(s):
Atulya Sarin Alan C. Shapiro
CHAPTER 1: INTRODUCTION
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CHAPTER 1 INTRODUCTION Chapter 1 emphasizes the internationalization of business and economic activity that has occurred since the end of World War II. Although international business activities have existed for centuries, primarily in the form of exporting and importing, only in the postwar period have multinational firms become preeminent. The distinguishing characteristic of the MNC is its emphasis on global, rather than affiliate, performance. Specifically, MNCs ask, “Where in the world should we build our plants, sell our products, raise capital, and hire personnel?” Thus the true MNC is characterized more by attitude than the physical reality of an integrated, global system of marketing and production activities. It involves looking beyond the boundaries of the home country and treating the world as “our oyster.” After stimulating student interest with this vision of the MNC, I then introduce the financial decisions that MNCs must make. I begin by discussing the key concepts and lessons from domestic finance that apply directly to international corporate finance. The lessons include the emphasis on cash flow rather than accounting earnings, the time value of money, the importance of taxes, and the unwillingness of investors to reward companies for activities (like corporate diversification) that investors could replicate for themselves at no greater cost. The key concepts, which I point out will arise time and again in the course, are arbitrage, market efficiency, and the separation of risk into systematic risk, which must be rewarded, and unsystematic risk, which is not rewarded. The latter concept, of course, is the intuition underlying both the capital asset pricing model (CAPM) and the arbitrage pricing theory (APT). Although imperfect, the theoretical framework of domestic corporate finance provides a useful frame of reference, and understanding it is essential before proceeding with the more complex aspects of international financial management. I devote some time to explaining that total risk matters, even if the CAPM or APT holds. Otherwise, the astute student will see a conflict between the irrelevance of unsystematic risk and hedging activities. I then outline the key decision areas in international financial management: foreign exchange risk management, managing working capital and the internal financial system, financing foreign units, capital budgeting, and evaluation and control. I emphasize the additional parameters that MNC financial executives must cope with, including multiple currencies, rates of inflation, tax systems, and capital markets, as well as foreign exchange and political risks.
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INSTRUCTORS MANUAL: FOUNDATIONS OF MULTINATIONAL FINANCIAL MANAGEMENT, 6TH ED.
SUGGESTED ANSWERS TO “THE DEBATE OVER OUTSOURCING” 1. What are the pros and cons of outsourcing? ANSWER. PROS: Outsourcing enables Americans to buy services less expensively abroad, increases U.S. productivity, and enables U.S. companies to cut their costs while improving quality, time to market, and capacity to innovate. It also allows the U.S. to use its comparative advantage in financial, managerial, and technical services by specializing in and exporting such services as higher-end computer programming, management consulting, engineering, banking, telecommunications, and legal work. CONS: As with any kind of trade, importing of services through outsourcing results in the loss of jobs for Americans previously employed in providing those services. Outsourcing may also cause U.S. companies that provide these services to go out of business. 2. How does outsourcing affect U.S. consumers? U.S. producers? ANSWER. As the answer to part a) points out, outsourcing allows companies to buy services less expensively abroad. Competitive pressures force companies to pass these savings along to consumers in the form of lower-priced goods and services. U.S. producers are able to boost productivity and cut costs while improving quality, time to market, and capacity to innovate. As such, American companies are better able to compete. This competition, however, forces companies to pass most of their savings from outsourcing through to their customers. 3. Longer term, what is the likely impact of outsourcing on American jobs? ANSWER. The longer-term effect of outsourcing on U.S. jobs should be insignificant. Trade has little, if anything, to do with the quantity of jobs in an economy but rather the nature and distribution of those jobs in various occupations. Outsourcing should lead to higher average productivity of those jobs that Americans work at and, hence, to higher wages and benefits. 4. Several states are contemplating legislation that would ban the outsourcing of government work to foreign firms. What would be the likely consequences of such legislation? ANSWER. Such legislation would result in less efficient and more expensive government. The end result would be higher taxes or, if taxpayers balk, fewer government services. SUGGESTED ANSWERS TO CHAPTER 1 QUESTIONS 1. Explain how globalization may affect even a small business in your local area. ANSWER. Globalization entails opening national borders to enable freer movement of goods and services. Due to the rapid decrease in communication and transportation costs over the last few decades, many firms find it cheaper to source products from foreign countries. Also, firms are now aware of international market opportunities and locate their plants and facilities abroad. As a result, the competition faced by any business is now more global rather than merely local. A small business in any local area now faces competition from both large MNCs and similarly situated businesses that take advantage of their international experience as well as internationally sourced products.
CHAPTER 1: INTRODUCTION
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2. Opponents of globalization and outsourcing argue that locating manufacturing activities abroad causes a loss of U.S. jobs. However, total employment figures reveal that rather than resulting in a net loss of jobs, employment has actually increased. Also, the average wages of workers have increased. How would you account for this discrepancy between what the critics say and what statistics reveal? ANSWER. Globalization is a two-way street. While some U.S. firms locate their plants overseas, several foreign companies have also invested in the U.S. economy and located their plants here. For example, major foreign automobile manufacturers such as Toyota and BMW have set up manufacturing plants in the U.S. and created numerous U.S. jobs. Also, over the last 25 years, the U.S. economy has experienced unprecedented productivity growth due to the increase in trade from globalization. The net impact of this productivity growth as measured in output per hour has been such as to increase the inflation-adjusted worker compensation. Thus, while critics of globalization look at only one side of the picture and point to job losses due to outsourcing, they neglect to take into account the job creation due to foreign investment in the U.S. and the increase in trade due to globalization. Critics also ignore the fact the increased opportunities for trade due to globalization result in high-value-added services being performed in the U.S. and the increase in productivity of the U.S. worker. As a result, worker wages have also gone up. 3. Elaborate on the benefits of a proactive approach to globalization and global competition. ANSWER. Rather than react to globalization, firms benefit by facing globalization and global competition head on. Globalization and global competition unleash the forces of creative destruction, whereby new technologies and new methods of business force out poorly performing competitors. To take advantage of the full potential of globalization and to counter global competition, many firms adopt new technologies, improve production methods, explore new markets, and introduce new and better products. The results of such improvements are clear in terms of the lower prices and expanded choices for consumers. Thus, proactive firms stay ahead of their competition by taking advantage of the various benefits of globalization and the expanded trade opportunities. 4. What are the various reasons for the emergence of multinational firms? ANSWER. The primary reason for the emergence of MNCs is the international mobility of several factors of production. MNCs emerge to take advantage of globally available raw materials, markets, specialized skills, and knowledge. Also, firms may become multinational to keep domestic customers that have moved abroad or to exploit financial market imperfections. These are elaborated below. SEARCH FOR RAW MATERIALS.
Some firms become MNCs to exploit the raw materials that can be found overseas, such as oil, coal, minerals, and other natural resources.
MARKET SEEKING.
Some firms become MNCs to exploit foreign markets for their products. Since the same product may be demanded in different countries, MNCs not only take advantage of the marketing opportunities, but also gain from the economies of scale obtained by selling large volumes across different foreign markets.
COST MINIMIZATION.
Companies also become MNCs to seek out lower-production-cost sites. Specific skills needed for production may be available at lower costs in some countries, and MNCs may locate plants specializing in specific aspects of production, such as assembly or fabrication, in those countries.
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INSTRUCTORS MANUAL: FOUNDATIONS OF MULTINATIONAL FINANCIAL MANAGEMENT, 6TH ED.
KNOWLEDGE SEEKING.
Some firms enter foreign markets to gain information and experience that are expected to prove useful elsewhere. Especially in industries characterized by rapid product innovation and technical breakthroughs, firms obtain technical product and process knowledge, which they leverage in other countries.
KEEPING DOMESTIC CUSTOMERS.
Suppliers of goods or services to MNCs often follow their customers abroad to guarantee them a continuing product flow. In the process, these firms also become MNCs.
EXPLOITING FINANCIAL MARKET IMPERFECTIONS. Companies may find it advantageous to reduce taxes and
circumvent currency controls when operating in multiple foreign markets. Doing so enables them to obtain greater project cash flows and lower costs of funds compared to a purely domestic firm. 5. Given the added political and economic risks that appear to exist overseas, are MNCs more or less risky than purely domestic firms in the same industry? Consider whether a firm that decides not to operate abroad is insulated from the effects of economic events that occur outside the home country. ANSWER. Individual foreign projects may face more political and economic risks than comparable domestic projects. Yet MNCs are likely to be less risky than purely domestic firms because much of the risk faced overseas is diversifiable. Moreover, by operating and producing overseas, the MNC has diversified its cost and revenue structure relative to what it would be if it were a purely domestic firm producing and selling in the home market. It is important to note that domestic firms are not insulated from economic changes abroad. For example, domestic firms face exchange risk because their competitive positions depend on the cost structures of both foreign and domestic competitors. Similarly, changes in the price of oil and other materials abroad immediately lead to changes in domestic prices. 6. How is the nature of IBM’s competitive advantages related to its becoming an MNC? ANSWER. IBM is selling more than black boxes; it is selling a stream of services associated with its computers. In effect, customers are buying the company. To provide customers with what they think they are buying, IBM must be there on the spot. This enables IBM to service customers’ machines as well as tailor software and systems to their specifications. 7. If capital markets were perfect, i.e., capital could move freely across national borders, would MNCs still exist? Why? Or, why not? ANSWER. Even if capital moved freely across national borders, MNCs would still exist, because MNCs bring a host of firm-specific knowledge and advantages along with capital to the countries in which they operate. Such advantages may include unique products, processes, technologies, patents, specific rights, or specific knowledge and skills. These advantages can be used profitably in foreign markets. Moreover, MNCs are better able to apply the knowledge and skills gained in their prior operations in other countries to each new country that they enter. Thus, from the point of view of a country attracting foreign capital, the capital that is brought in by an MNC brings with it firm-specific advantages that yield better returns than the capital that is simply borrowed from a foreign country.