CH 13 & 14

CH 13 & 14 - 182 Chapter 13 Okapier In the...

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Unformatted text preview: 182 Chapter 13 Okapier In the following exercise, place a letter from the right column with the correct number in the left column. 1. Direct Foreign . lower average cost per unit resulting from increased Investment production 2. Economies of Scale . investment in real assets (such as land, building, or even existin lants in forei 11 countries 1) Expected financing rate of a portfolio of two currencies rp = wArA +wBrJg 2) Variance of a two-currency portfolio’s effective financing rate 2 __ 2 2 2 2 0'? — wAaA + 141303 + 2wAwBaA03(CORRAB) Definitional Problems 1. The investment in real assets (such as land, buildings, or even existing plants) is referred to as 2. Even if an MNC’s growth is limited at home, it may be able to attract in foreign countries. 3. The realization of lower average cost per unit resulting from increased production is known as 4. Due to the , more homogenous products can be sold in all European countries. This is because it removed trade barriers between those countries. 5. An MNC will often attempt to set up production in locations where the are cheap. 6. When a foreign currency is perceived by a firm to be , the firm may consider direct foreign investment in that country, as the initial outlay should be relatively low. Direct Foreign Investment 183 7. Several Eastern European countries that became part of the in 2004 were targeted for new DFI by MNCS that wanted to reduce manufacturing costs. 8. Since economies of countries do not move perfectly in tandem over time, net cash flow from sales of products across countries should be more than comparable sales if the products were sold in a single country. 9. More than one-half of all DFI by US. firms is in countries. 10. When economic conditions of two countries are not highly , then a firm may reduce its risk by diversifying its business in both countries rather than concentrating in just one. 11. As more projects are initially added to a portfolio ofprojects, the portfolio variance should . However, after some point, the average reduction in variance becomes 12. The term refers to a minimum risk for a given expected return. 13. An MNC is better off if the efficient portfolio fi'ontier is further to the , since this reflects less risk. 14. MNCs can probably achieve more desirable risk-return characteristics from their project portfolio if they sufficiently diversify among products and markets. 15. DFI may be perceived as a remedy of national problems by host governments. For example, DFI may provide needed or 16. The ability of a host government to attract DFI is dependent on the country’s markets and resources, as well as government and 17. If a foreign subsidiary has a use for funds that would be of more value than the parent’s use, the subsidiary should those funds. 18. The efficient frontier of international project portfolios may be further to the left than the efficient frontier of purely domestic portfolio because of higher benefits. 19. barriers are implicit barriers to DFI in some countries that refer to the procedure and documentation requirements involved. 20. To limit or prevent international acquisitions, some governments may restrict Answers to Definitional Problems 1. direct foreign investment (DFI) 6. undervalued 2. demand 7. European Union 3. economies of scale 8. stable 4.. Single European Act 9. European 5. factors of production 10. correlated 184 Chapter 13 11. decrease; negligible 16. regulations; incentives 12. efficiency 17. retain 13. left 18. diversification 14. geographic 19. “red tape” 15. employment; technology 20. foreign ownership I T rue/F alse Problems a t i gt @vfl Direct foreign investment (DFI) represents investment in real assets (such as land, buildings, or even existing plants) in foreign countries. 2. Although direct foreign investment is sometimes conducted, benefits are rarely realized. 3. Many developing countries, such as Argentina, Chile, and Mexico, have been perceived as the most attractive sources of new demand. 4. The term economies of scale refers to a lower total production cost as production is increased. 5. An MNC may enter a foreign market because rates of return there are significantly higher than those available at home. 6. MNCs often attempt to set up production in locations where land and labor are expensive, because expensive factors of production indicate high demand. 7. Due to market imperfections, the cost of factors of production (such as labor) may differ substantially across countries. 8. Both the use of foreign raw materials and the use of foreign technology may motivate an MNC to establish a subsidiary in a foreign country. 9. If a particular firm possesses an advanced technology that has been exploited at home, it is probably not a good idea to establish a subsidiary overseas because the technology will probably already have been exploited there. lfb‘ifffhé” shifts of DFI to low-cost Eastern European countries will make manufacturing more efficient and competitive, but the tradeoff is thousands of jobs lost in Western Europe. 11. There are various reasons an MNC may decide to establish a foreign subsidiary. However, it must realize that economics of countries typically move in tandem over time. Thus, the volatility of cash flows will probably not be reduced because of direct foreign investment. 12. The optimal method for a firm to penetrate a foreign market is partially dependent on the characteristics of the market. 13, 51" We reasons for the increased focus of DFI in Europe are the Single European Act and the “if” addition of several Eastern European countries to the European Union in 2004. 14. In assessing the risk of an individual project, the expected correlation of the new project’s returns with those of the prevailing business must not be considered. Direct Foreign Investment N H e s 185 . If a new project is located in a foreign country rather than at home, unless the project’s returns are perfectly positively correlated with those of the prevailing business of the firm, the variability of returns is reduced. . As more projects are added to a portfolio of projects, the variability of the portfolio is reduced. This reduction is greater the smaller the number of projects in the portfolio. The term “efficient” refers to the positive relationship between risk and returns. That is, the higher the risk, the higher the return. Because of greater diversification benefits, the efficient portfolio frontier of multinational projects probably lies to the left of the efficient portfolio frontier for domestic projects. . MNCs can probably achieve more desirable risk-return characteristics from their project portfolios if they sufficiently diversify among products and geographical markets. Once a decision to establish a foreign subsidiary has been made, it is irreversible. Therefore, no periodic monitoring of the project is necessary. . Foreign governments may subsidize direct foreign investment in their country if they believe DFI will provide needed employment and/or technology. . Some types of direct foreign investment will be more attractive to some governments than others. . MNCs wants to avoid a situation in which they pursue DFI under a government that is likely to be removed after the DFI occurs. The local firms of some industries in particular countries have substantial influence on the government and will likely use their influence to encourage competition from MNCs that attempt DFI. Answers to T rue/F alse Problems HPWFPP?‘ Hui—woo PI‘P' ' T 13. T F 14. F T 15. T F 16. T T 17. F F 18. T T 19. T T 20. F F 21. T T 22. T F 23. T T 24. F 186 Chapter 13 Multiple Choice Problems gt 1. Direct foreign investment is commonly considered by MNCs because it allows the MNC to at»! Attract new sources of demand. b. Enter profitable markets. c. React to exchange rate movements. _ d. React to trade restrictions. i, ' e All of the above 2 I is not a revenue-related motiVe for direct foreign investment (DFI). Attracting new sources of demand b. Fully benefiting from economies of scale c Exploiting monopolistic advantages V“ d Reacting to trade restrictions 6 Diversifying internationally 3 is not a cost~related motive for direct foreign investment (DFI). Using foreign factors of production ’0. Using foreign raw materials c Using foreign technology d Reacting to trade restrictions e Fully benefiting from economies of scale @ 4. I irect foreign investment by a US. firm is commonly motivated by . . Special subsidies by the US. government b. Guarantees on any debt of the firm provided by the US. government c. Ch r f r reduction '“ None of the above ‘_ 5.; is not a country mentioned in your text viewed as an attractive source of if new demand. a. Argm . "is. Great Britain 0. Mexico_ d. China e. None of the above 6. When a foreign currency is perceived by a firm to be , the firm will probably ) direct foreign investment in that country. . 99W Undervalued; not consider . (Mng a and c b and c a: ‘ 99-957 Direct Foreign investment 187 i 7. iWhich of the following is not an advantage associated with international diversification? [a \ a.Net cash flows from sales 6f products across countries should be more stable than comparable sales if the products were sold in a single country. b. The ppssibflfiy ofa liquidity deficiency/"is less likely than without international diversificationTeverythifigfielsEbeing equal. c- The firm mar saint slower. ligaments}. as shareholders», and, sissiitorspstcsirs the soles risk to be lower._ " " With international diversification, the MNC is better able to react to trade restrictions \ imposed by a single government than it is without international diversification. 8. [According to your text, the best means of using direct foreign investment to attract new - \j‘ sources of demand is probably to H a. Establish a subsidiary or acquire a Competitor in a new market. @‘ b. Establish'a subsidiary/iii "a'ma'rk'et 3in'w1ii2'ihm't’6ii‘gher trade restrictions will adversely affect the firmfs export volume. c. Establish subsidiaries in markets whose business cycles differ from those where existing subsidiaries are based. 6.. Establish an additional subsidiary in an existing market than can sell products produced elsewhere. 9. J‘The best means of using direct foreign investment (DFI) to fully benefit from economies of V ‘ scale is probably to " " ' ' ' ' a. Acquire a competitor that has controlled its local market. I b. Establish a subsidiary in a new market than can sell products produced elsewhere, this allows for increased production and-possibly greater production efficiency." '7 7 c. Establish a subsidiary inma market that has relatively'low'costs bi labor and land; sell the finished product t countries where the cost of production is higher. (1. Establish a subsidiary in a market in which raw materials are cheap and accessible; sell the finished product to countries in which the raw materials are more expensive. 10. "he best means of usingwcfirect foreign investment (DFI) to fully benefit from cheap foreign t. factors of production is probably to I I I _ __ a. Acquire a competitor that has controlled its local market. b. Establish a subsidiary in a new market than can sell products produced elsewhere; this allows for increased production and possibly greater production efficiency. 0. Establish a subsidiary in amarket‘that has relativelylgwcostswgflabor andland; sell the finiShesrzmdsct.t,ssfifiséwhsre thee .t.o.f.pm£lllct.. _n_ is higher. d. Establish a subsidiary in a market in which raw materials are cheap and accessible; sell the finished product to countries in which the raw materials are more expensive. Diiect Foreign Investment 189 SCIWA \\ w l? 16. In general, the risk reduction achieved by adding projects to a portfolio is _ the I the number of projects in the portfolio prior to the addition. fig Greater; greater ' " b. Smaller; greater 0 Greater; smaller (1. Smaller; smaller 6 b and c .. :T r j 17.5 The . it. the correlation in project returns is over time, the lift” ‘5’ i) will be the i "my project portfolio risk as measured by the portfolio variance. Lower; . .Jm“”"“ a. b. Higher; lower c d Lower; higher None of the above Q/ 18. ,-‘Which of the following is not true,"regarding host government attitudes towards direct foreign 4“ investment (DFI)? I I a. Host governments may offer incentives to MNCs in the form of subsidies in certain circumstances. b. Host governments generally perceive DFi as a remedy for their national problems. c. The ability of a host government to attract DFI is dependent on the country’s markets and resources. d. Some types of DFI will be more attractive to some governments than to others. e. All of the above are true at” There is exactly one point on the efficient frontier that is optimal for every MNC, regardless of its degree of risk aversion. b. The efficient frontier for international projects will probably lie to the left of the efficient frontier for domestic projects. c. Each point on the efficient frontier represents a portfolio of projects as opposed to an individual project. (:1. a and c are false c. All of the above are true d} 19. ich of the following is not true regarding the efficient frontier considered by MNCS? . l 41 fig 20. general, much of the direct foreign investment (DFI) by US. firms is in a. ln’Canada b. Asia c. Mexico e. Chile ’4 W 21. Which of the following is’n‘lsrti: barrier to DFI? " a. __Barfiers that restrict ownersh bi", “Redtap'eflbarriers l c. Industry barriers d. Politicalinstability 7 c. All of the above are barriers 190 Chapter 13 Answers to Multiple Choice Problems (4Zumffifi6fi1m2+m4xmumxflmsa wwp/ ~9¢H9w§wwr OUWQQU‘OQUO 0. 1 .)X{ (mupfiam$=u% l¥b wmymmadm Multinational Capital Budgeting 195 C/\\ueker\ : Key Terms Matching l In the following exercise, place a letter from the right column with the correct number in the left column. a. a computer—based analysis that includes the generation of a probability distribution for NPV based on a range of possible values for one or more input variables b. a tax provision allowing corporations to use negative earnings in one year to offset earnings in previous years c. a tax provision allowing corporations to use negative earnings in one year to offset earnings in subsequent years additional business opportunities contained in a project which may enhance the value of a project e. use of what-if scenarios for values of input variables in' capital budgeting analysis; the objective is to determine how sensitive NPV is to alternative values of the in ut variables Net Operating Loss ‘ Carryback 2. Net Operating Loss Carryforward Real Options Summary of Formulas l) Break-even salvage value SVn = [10— CF’ r](1 + k)” M (1 + k) 2) Net present value NPV = —10+ CE + SV” M (1+ k)’ (1+ k)" Deflnitional Problems 1. It could be argued that capital budgeting for a multinational project should be conducted from the viewpoint of the , since it will be responsible for administering the project. 2. Critics may argue that capital budgeting for a multination project should be conducted from the viewpoint of the , especially if it provides some of the project financing. 196 Chapter 14 3. If the parent’s government imposes a high tax rate on remitted funds, a project may be feasible from the point of view, but not from the point of view. 4. If a host government restricts the remittances from a foreign subsidiary, a possible solution is to let the subsidiary obtain partial for the project. 5. If the parent charges the subsidiary administrative fees, the earnings from the project will appear to the parent and to the subsidiary. 6. If a multinational project is assessed from the subsidiary’s perspective, forecasted are irrelevant for project assessment. 7. A perspective is appropriate in attempting to determine whether a project will enhance the firm’s value. 8. Any project that can create a net present value for the parent should enhance shareholder weaith and, consequently, be accepted. 9. The initial investment in a project may include not only whatever is necessary to start the project but also additional funds in the form of to support the cash cycle of the project. 10. To forecast consumer demand for a project, one should begin with a forecast of 11. To forecast selling price, variable costs, and fixed costs, consideration must be given to expected in the foreign country. 12. Once the relevant cash flows of a proposed project are estimated, they can be discounted at the project’s , which may differ from the MNC’s cost of capital because of that particular project’s risk. 13. It is extremely important that MNCs incorporate the degree of for any input that is used in the project evaluation (capital budgeting). Otherwise, MNCs may take on a project by mistake. 14. A commonly used capital budgeting technique is to estimate the cash flows and salvage value to be received by the parent and compute the of the project. 15. If a project’s NPV is positive, the project should probably be ; if it is negative, the project should probably be 16. From the parent’s point of view, of the foreign currency w0uld be favorable when assessing a foreign project. 17. The exchange rates of highly inflated countries tend to over time. Thus, even if subsidiary earnings are inflated, they will be deflated when converted into the parent’s home currency. 18. Unlike domestic capital budgeting issues, foreign should probably be explicitly considered in the cash flow analysis. Multinational Capital Budgeting 197 19. In general, increased investment by the parent relative to the subsidiary causes exchange rate exposure to the parent because the cash flows remitted to the parent will be larger. 20. Projects financed entirely with retained earnings of the foreign subsidiary could be assessed by regarding the subsidiary’s investment as a(n) , since the funds could be remitted to the parent rather than invested in the foreign project. 21. Blocked funds may penalize a project if the return on the resulting forced reinvestment in the foreign country is than the required rate of return on the project. 22. The of an MNC’s project typically has a significant impact on the project’s NPV. 23. Some foreign projects may have a impact on prevailing cash flows. For example, creation of a foreign subsidiary may result in increased sales by the parent to that subsidiary. 24. Some capital budgeting projects contain , in that they may allow for additional business opportunities. 25. The three common methods to adjust the capital budgeting process for risk are use of a discount rate, analysis, and 26. The objective of is to determine how sensitive the NPV is to alternative values of the input variables. 27. In a computer-conducted , the computer randomly picks values for the input variables and computes an NPV. This process is repeated maybe 100 times to generate a distribution of NPVS for a project. 28. An international may be preferable to the establishment of a new subsidiary because the firm can immediately expand its international business and benefit from existing customer relationships. 29. Foreign projects that have been implemented must be assessed from time to time to determine whether they should be continued or 30. When negative earnings from operations are allowed to be carried back or forward to offset earnings in other years, this is known as and , respectively. 31. To minimize taxes, MNCs may attempt to use . For example, a subsidiary located in a high tax rate country may purchase supplies from a subsidiary located in a low tax rate country at relatively high prices to shift income from the former to the latter. Answers to Definitional Problems 1. subsidiary 3. subsidiary’s; parent’s 2. parent 4. financing 198 Chapter 14 5. high; low 19. more 6. exchange rates 20. opportunity cost 7. parent’s 21. less 8. positive 277 22. salvage value 9. working capital ' 23. favora e \ 10. market share 24. real options 1’ 11. inflation 25. ris...
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