Chapter 20 Outline

Chapter Summary

This chapter was concerned with financial management in the international business. We discussed how investment decisions, financing decisions, and money management decisions are complicated by the fact that different countries have different currencies, different tax regimes, different levels of political and economic risk, and so on. Financial managers must account for all of these factors when deciding which activities to finance, how best to finance those activities, how best to manage the firm's financial resources, and how best to protect the firm from political and economic risks (including foreign exchange risk). This chapter made the following points:

1. When using capital budgeting techniques to evaluate a potential foreign project, a distinction must be made between cash flows to the project and cash flows to the parent. The two will not be the same thing when a host-country government blocks the repatriation of cash flows from a foreign investment.

2. When using capital budgeting techniques to evaluate a potential foreign project, the firm needs to recognize the specific risks arising from its foreign location. These include political risks and economic risks (including foreign exchange risk).

3. Political and economic risks can be incorporated into the capital budgeting process either by using a higher discount rate to evaluate risky projects or by forecasting lower cash flows for such projects.

4. The cost of capital is typically lower in the global capital market than in domestic markets. Consequently, other things being equal, firms prefer to finance their investments by borrowing from the global capital market.

5. Borrowing from the global capital market may be restricted by host-government regulations or demands. In such cases, the discount rate used in capital budgeting must be revised upward to reflect this.

6. The firm may want to consider local debt financing for investments in countries where the local currency is expected to depreciate.

7. The principal objectives of global money management are to utilize the firm's cash resources in the most efficient manner and to minimize the firm's global tax liabilities.

8. Firms use a number of techniques to transfer funds across borders, including dividend remittances, royalty payments and fees, transfer prices, and fronting loans.

9. Dividend remittances are the most common method used for transferring funds across borders, but royalty payments and fees have certain tax advantages over dividend remittances.

10. The manipulation of transfer prices is sometimes used by firms to move funds out of a country to minimize tax liabilities, hedge against foreign exchange risk, circumvent government restrictions on capital flows, and reduce tariff payments.

11. However, manipulating transfer prices in this manner runs counter to government regulations in many countries, it may distort incentive systems within the firm, and it has ethically dubious foundations.

12. Fronting loans involves channeling funds from a parent company to a foreign subsidiary through a third party, normally an international bank. Fronting loans can circumvent host-government restrictions on the remittance of funds and provide certain tax advantages.

13. By holding cash at a centralized depository, the firm may be able to invest its cash reserves more efficiently. It can reduce the total size of the cash pool that it needs to hold in highly liquid accounts, thereby freeing cash for investment in higher-interest-bearing (less liquid) accounts or in tangible assets.

14. Multilateral netting reduces the transaction costs arising when a large number of transactions occur between a firm's subsidiaries in the normal course of business.

15. The three types of exposure to foreign exchange risk are transaction exposure, translation exposure, and economic exposure.

16. Tactics that insure against transaction and translation exposure include buying forward, using currency swaps, leading and lagging payables and receivables, manipulating transfer prices, using local debt financing, accelerating dividend payments, and adjusting capital budgeting to reflect foreign exchange exposure.

17. Reducing a firm's economic exposure requires strategic choices about how the firm's productive assets are distributed around the globe.

18. To manage foreign exchange exposure effectively, the firm must exercise centralized oversight over its foreign exchange hedging activities, recognize the difference between transaction exposure and economic exposure, forecast future exchange rate movements, establish good reporting systems within the firm to monitor exposure positions, and produce regular foreign exchange exposure reports that can be used as a basis for action.