Study Notes on Multinational Financial Management

Chapter 17: Multinational Financial Management

Learning Outcomes

After studying this chapter, you will be able to:

• 17-1 Summarize six reasons that companies "go global."

• 17-2 List nine ways that multinational and domestic financial management differ.

• 17-3 Illustrate transactions between countries with different currencies.

• 17-4 Explain why the fixed exchange rate system isn't used by IMF members.

• 17-5 Discuss the determinants of floating exchange rates.

• 17-6 Contrast currency intervention and currency manipulation.

• 17-7 Show how pegged and managed floating rate systems function.

• 17-8 Utilize forward exchange rates to manage exchange rate risk.

• 17-9 Determine home interest rates by using forward and spot exchange rates.

• 17-10 Infer equilibrium spot rates by means of purchasing power parity relationships.

• 17-11 Identify relationships among inflation, interest rates, and exchange rates.

• 17-12 Outline key features of international money and capital markets.

• 17-13 Compare domestic versus multinational capital budgeting.

• 17-14 Name reasons that international capital structures vary.

• 17-15 Define key aspects of multinational working capital management.

Case Study: Medtronic

• Background: Founded in 1949 in Minnesota, Medtronic began repairing electronic medical equipment.

• Key Milestones:

  • 1960s: Nearly went bankrupt, but recovered with venture capital.

  • 1967: Launched global operations.

  • 1977: Went public on NYSE.

  • By 2014: Sales exceeded $17 billion in over 140 countries.

• Recent Developments:

  • 2015: Acquired Covidien, an Irish company.

  • Reincorporated in Ireland for favorable tax treatment, referred to as a "tax inversion."

• Political Context: Tax inversion strategies are currently under scrutiny in U.S. politics.

Managing Global Operations

• Intrinsic Value of a Firm: Determined by:

  • Size and timing of future free cash flows.

  • Host country's regulatory environment.

  • Affected by exchange rates, cultural factors, global financial markets, and political risk.

• Key Calculation:

  • Value = $rac{FCF<em>1}{(1 + WACC)^1} + rac{FCF</em>2}{(1 + WACC)^2} + …$

  • Where FCF = Free Cash Flow, WACC = Weighted Average Cost of Capital.

• Financial Management Issues: Multinational corporations face unique challenges not present for domestic companies.

17-1: Multinational Corporations

• Definitions and Scope:

  • Terms include multinational corporations, transnational corporations, multinational enterprises, and global corporations.

  • Engage in direct investments, including raw material extraction to manufacturing and distribution operations.

• Reasons Companies Go Global:

  1. Broaden Markets: Example: Apple has more users in China than in the U.S.

  2. Seek Raw Materials: Example: ExxonMobil.

  3. Seek New Technology: Companies may pursue innovations globally.

  4. Seek Production Efficiency: Example: GM produces vehicles in lower-cost regions.

  5. Avoid Political and Regulatory Hurdles: Minimizing taxes and enhancing freedom of operation.

  6. Diversification: Geographic diversification reduces risk due to non-correlated economies.

• MNC Employment Trends:

  • U.S. multinational employment grew at 1.5% vs. 5.5% internationally.

17-2: Multinational Versus Domestic Financial Management

• Differences: Nine key differences identified:

  1. Currencies: Multinational companies deal with multiple currencies.

  2. Languages: Language barriers can impact communication and management.

  3. Cultures: Cultural differences affect risk attitudes and company values.

  4. Economic Systems: Range from free-market to command economies.

  5. Legal Systems: Variations can complicate legal compliance and operations.

  6. Taxation: Differences can vastly affect after-tax cash flows.

  7. Government Intervention: Interactions with governments can dictate company operations.

  8. Political Risk: Foreign assets may face nationalization or expropriation risks.

  9. Terrorism and Crime: Companies face heightened security risks affecting operations.

17-3: Exchange Rates

• Historical Context: The gold standard was a monetary system where currencies were backed by gold until abandoned around World War I.

• Exchange Rate Definitions:

  • Foreign Exchange Rate: Units of currency exchanged for one unit of another.

• Foreign Exchange Notation:

  • Example: USD/JPY = 101.01 means 1 dollar is worth approximately 101.01 yen.

• Direct Quotes vs. Indirect Quotes:

  • A direct quote indicates home currency per unit of foreign currency; the indirect is the opposite.

17-3b: Reporting Foreign Exchange Rates

• Conventions:

  • Normal practice for major currencies is to report direct quotes for euros and British pounds, while other currencies are quoted indirectly.