An MNC, FinnMilk Oy, Planning in the Financial Perspective

1
LUT School of Business & Management
A220A0200, International Financial Management
Ahmed Sheraz
PAPER TYPE: TERM PAPER
FinnMilk Oy
Date: 21.10.2016
0505812 Yaxin Liu
0505867 Yuqing Zhang
0500341 Ossai Chukwuka
0500192 Sultan Islam
0499698 Dmitriy Sheriyazdanov

2
Tables and Figures Content
Introduction................................................................................................................................4
Section 1: Developing Our Idea.................................................................................................6
Section 2: Assessing Country Factors That Will Affect the Demand for our Product............10
Section 3: Using the Foreign Exchange Market ......................................................................13
Section 4: Monitoring Movements in the Foreign Currency's Value ......................................16
Section 5: Using Currency Futures and Options......................................................................18
Section 6: Monitoring Central Bank Intervention ...................................................................20
Section 7: Assessing Spot and Forward Rates.........................................................................22
Section 8: Determining Whether IFE Holds............................................................................23
Section 9: Monitoring Exchange Rate Trends.........................................................................25
Section 10: Recognizing Exposure to Exchange Rate Risk.....................................................28
Section 11: Denominating Receivables in Euro ......................................................................30
Section 12: Establishing a Subsidiary in Foreign Country......................................................31
Section 13: Deriving Required Rate of Return for an International Project............................33
Section 14: Estimating Cash Flows of an International Project ..............................................36
Section 15: Assessing Exposure to Country Risk....................................................................40
Section 16: Capital Structure Decisions ..................................................................................47
Section 17: Long-Term Debt-Denomination Decision............................................................51
Section 18: Ensuring Payment for Exports..............................................................................53
Section 19: Financing in Foreign Currency.............................................................................54
Section 20: Concluding and Overall Assessment ....................................................................55
References................................................................................................................................57
Appendices…………………………………………………………………………………………....64

3
Table content
Figure 1: China Milk Powder Imports 2003-2012....................................................................7
Figure 2: Foreign Dairy Companies in China...........................................................................8
Figure 3: Infant Food Market and Milk Powder.......................................................................9
Figure 4: Breast Feeding Rate in China..................................................................................11
Figure 5: Number of Newborns Every Year 1929-2011 ........................................................11
Table 1: the data of buying and selling price of BOC .............................................................13
Figure 6: Trend of the change of the value of CNYfor one month.........................................14
Figure 7: Trend of the change of the value of CNYfor 3 months...........................................14
Figure 8: Trend of the change of the value of CNYfor half a year.........................................15
Table 2: Interest rate differentials of China and Euro area.....................................................24
Figure 10 : Exchange rates of Euro and Yuan from July 2015 to September 2016 ..............25
Figure 11 : Percentage change in exchange rates of Euro and Yuan......................................25
Table 3: EUR/CNY. Long-term. Exchange rate changes from 2007 till 2017.......................26
Table 4: EUR/CNY. Short-term. Exchange rate changes from 01.01.2014 till 16.10.2016...26
Figure 14: Graphical analysis of exchange rate changes from 01.01.2014 till 16.10.2016....28
Table 5: Short-Term & Long-Term Loan Rates in China .......................................................35
Table 6: Estimation Matrix......................................................................................................40
Figure 15: Economic Indicators of China (Trading Economics)............................................41
Figure 16 Euribor interest rates...............................................................................................52
Table 7: The development of the Nordea Prime Rate and the Euribor rates ..........................53
Table 8: Interest rate in China.................................................................................................53

4
Introduction
Global demand for dairy has been than ever before. The irresistible growth of the world’s
population, rising incomes, urbanization and westernization of diets in counties like China
and India has led to the increased demand of dairy products (WWF, Dairy). The need for
sustainable growth of the dairy industry lies to the dairy companies and other associated
stakeholders.
Finland is one of the countries abundant with diary resources such as Milk in the world.
Moreover, if milk is abundant and available in different parts of Finland, we can say that
Finnish milk producers would benefit from comparative advantage in this industry.
China has been a dominant player in global dairy market. The average growth rate of China’s
dairy imports annually during 2002-2011 was around 30.57%, the dairy import value reached
2.6 billion US$ in 2011 (Wang & Sayed, 2013). So the increased dairy imports by China
have unveiled many opportunities for foreign companies.
We have agreed on choosing our company’s name as FINNMILK OY, a Finnish private
limited company targets to serve a niche market in the dairy industry. The company’s
primary product is infant milk powder (formula). We name the infant (baby) milk powder as
Finnimi, the company’s primary product. However, note that throughout the paper we use the
word ‘infant’ and ‘baby’ interchangeably due to its very closer meanings. Furthermore,
during writing the whole paper, we implicitly have expressed our knowledge, data and
information, views, and opinions by the name of our company, FinnMilk Oy with proper
sources and references where relevant.
FinnMilk Oy assumes that it is privately held equity owned company. After some years of its
birth, the company pursues other sources of capital in order to expand in the local and foreign
market. In the paper when we are talking about the company, FinnMilk Oy we have taken the
company’s perspectives to evaluate actions that affect the company as a whole. Even if the
company would take international projects such as establishing subsidiary, we have viewed
FinnMilk Oy as the parent perspective. We also assume that FinnMilk Oy is already
established business or company in Finland when it is planning to export or establish foreign
projects.

5
Primarily the company’s international project is to establish a subsidiary and in the paper it
calls its international project as the proposed project or proposed subsidiary or simply project.
Moreover, throughout the paper, the name of Chinese currency such as Chinese Yuan, RNB,
CNY expresses the same meanings that FinnMilk Oy uses interchangeably. The paper
concludes by critically unveiling the realistic factors that the company truly thinks before
making any decisions.

7
Section 1: Developing Our Idea
1. We have developed a business idea which is based on milk resource in Finland. The
resource would be utilized to produce milk powder for baby (infant). Since many countries in
the world are largely dependent on baby milk powder (formula), the business idea would be
well suited to international markets through the customization of the country’s needs.
Therefore, our aim is to gradually disseminate and expand the business idea to the countries
where the perceived need for baby milk powder is existent and imminent.
2. The name of the company is FinnMilk Oy and the product it plans to sell is infant milk
powder formula. Remember the company names its product brand as Finnimi. The country
with which the company plans to do international business and targets to sell Finnimi is
China. As China is one of the world’s largest dairy industries, the production and
consumption of dairy products of the country has been increasing by 12.8 % per year on
averagei
.FinnMilk Oy targets Chinese market because the following chart shows how china’s
import of dairy products has been climbed steadily between 2003 and 2012.
Figure 1: China Milk Powder Imports 2003-2012
Source: Reproduced from Ryan Scott and Jianping Zhang, GAIN Report: China-Dairy and
Products Annual Report (Washington D.C.; USDA FAS, 2012).
China’s dependency in domestic milk production has been increasing rapidly in the past
years. However, China’s milk consumption is expected to increase 38% by 2022, resulting an
expected rise of dairy imports by 20%.Therefore, FinnMilk Oy decides that China is the
0,00
100,00
200,00
300,00
400,00
500,00
2003 2004 2005 2006 2007 2008 2009 2010 2011 2012
1,000(MetricTon)
Milk Powder Imports
Imports

8
potential country to export its brand Finnimi based on expected economic growth of the dairy
industry.
3. FinnMilk Oy plans to sell Finnimi brand to the local Chinese market through distributors
or retailers. Initially the company projects to export certain amount of products to Chinese
distributors via fixed contract. Chinese distributors include Hong Kong Traders (licensed
importer), convenience stores, supermarkets, Tesco Plc, hypermarkets etc. (USDA China
Retail Report 2014). The Company would have strategic planning to establish subsidiary in
China if the exporting business exceeds expectations and overall growth.
4. The economic outlook and demographic characteristics of China reflect the potential
consumers demand for infant milk powder formula. We, on behalf of the FinnMilk Oy have
conducted an online qualitative survey for infant milk powder demand in China and gathered
consumers response considered as primary data source (see appendix A for survey
questionnaire).
The results reveal that consumers feel free to buy foreign brands and they prefer quality
brand for baby milk powder. Besides, they emphasize on product’s ingredients and proper
quality. Consumers prefer to buy it from retail stores. Based on this information, FinnMilk
Oy decides to make quality baby powder and export to China through distributors.
On the basis of secondary evidences, the market share of top foreign companies reflects the
consumers demand for foreign dairy products’ in China. Foreign ownership of Chinese dairy
companies’ indicates that the market for infant milk formula is a rising trend in China.

9
Figure 2: Foreign Dairy Companies in China
Source: Reproduced from Xinjing Newspaper, data from AC Nielson and Chinese Dairy
Industry Association
According to the estimations, in 2012, the scale of China’s infant food market was about
CNY 60 billion, among which, the formula milk powder was CNY 51 billion accounting for
85%. By 2015, the scale of China’s infant food market will reach CNY 90 billion with nearly
CNY 80 billion of formula milk powder and CNY 10 billion of food supplements.
Figure 3: Infant Food Market and Milk Powder
The composite growth rate of infant formula milk powder market demand exceeds 15%; with
the speeding-up of urbanization, improvement of per capita income level and coming of the
fourth baby boom, it is predicted that China’s infant milk powder industry will usher in the
12,30%
11,70%
11,00%
8,70%
7,70%6,70%
5,70%
4,50%
3,90%
3,70%
24,10%
Infant Formula Market Share in China
Mead Johnson
Danone Dumex
Nestle's Wyeth
Beinmate
Abbott
Yili
Biostime
mengniu's Ya
Shengyuan
0
20
40
60
80
100
2012 2015
Billions
Infant Food Market
Formula Milk Powder

10
gold development period. Therefore, foreign companies like FinnMilk Oy can take advantage
of penetrating this market.
5. FinnMilk Oy has its supplies from Finland. The company’s business is based on Finnish
Milk and that milk would be used to make baby milk powder formula. The company seeks to
maintain high quality with its resources. To do business in China, the company has to hire
local labor. But the cheap labor in China is not the company’s millstone.
6. FinnMilk Oy would produce the product in Finland. The company would have to incur
expenses such as material cost, production cost, labor wages and other associated
expenditures in producing the product. The expenses will be incurred in Euros because the
company’s production and material procurement is in Finland.

11
Section 2: Assessing Country Factors That Will Affect the Demand for our Product
FinnMilk Oy analyzes several factors that could affect the demand of the product, Finnimi.
i. Demographics Factors: China has reformed the family planning system from one-child
policy and it would allow 60 million couples eligible to have a second child. The reason for
the policy reform is to increase the number of young people. As a result, FinnMilk Oy
anticipates that the need for imported infant milk powder would be increased in China with
the rising number of young population.
The breast feeding rate in China is relatively lower than the global average rate. The
decreased breast feeding rate is 28% in China, compared to global average 40%. So the
company estimates that the imported infant milk formula has higher demand in the Chinese
market.
Figure 4: Breast Feeding Rate in China
ii. Increased Baby Population: With the coming of the fourth baby boom, it is predicted that
the number of newborns every year will exceed 17 million and the 0-3-year-old babies will
maintain about 50 million in the future few years; the infant food market will focus on the
formula milk powder and food supplements.
0%
10%
20%
30%
40%
50%
China Global Average
Breast Feeding Rate
Breast Feeding
Rate

12
Figure 5: Number of Newborns Every Year 1929-2011
iii. Economic Factors: The demand for dairy products is likely to grow continually due to
increases in people’s disposable income. Personal income of Chinese people has risen in both
urban and rural areas in the past years. A research was conducted to see how the increased
disposal income contributes to the imported dairy products. In the research, Wang and Sayed
(2013, 6) stated in his empirical results by using Almost Ideal Demand System (AIDS) “A
1% increase in GDP per capita will result in a 1.21% increase in dairy import approximately,
holding other things constant”. He concluded that China’s import demand for dairy products
would likely to grow as per capita GDP increases.
iv. Host Government Control: The Chinese government policy influences the difficulty level
for taking entry into the local dairy industry. If the government restricts the foreign
companies coming into the Chinese market, the company should make more effort on the
quality and follow close to the line of Chinese import policy.
v. Quality: The quality is the most important factor for infant milk powder formula. Because
of baby milk formula scandal in China, the Chinese government has tightened regulations for
foreign companies. Besides, local consumers believe in foreign brand of baby milk formula
because they think that these brands are higher quality.
2. All of these aforesaid factors affect the demand of the company’s brand, Finnimi.
However, due to the host government high regulations in the dairy industry, the government
Newborns
each year

13
can intervene anytime in the industry. Moreover, the Chinese government also monitors the
Forex market to adjust any changes. Therefore, FinnMilk Oy critically considers the barriers
by the government that could adversely affect the flow of trade and thus, the demand of the
product.

14
Section 3: Using the Foreign Exchange Market
1. Bank of China will be our official bank.
Table 1: the data of buying and selling price of BOC
Type of
currenc
y

Exchan
ge rate
of Euro
to CNY
price of
purchasi
ng spot
exchang
e
(every
100
CNY)
Price of
purchasi
ng
foreign
cash
price of
selling
spot
exchang
e
Price of
selling
foreign
cash
Discount
price of
SAFE
Discoun
t price
of BOC
Release time

15
2. Chart: the trend of the change of the value of CNY (ONADA)
Figure 6: Trend of the change of the value of CNY for one month
Figure 7: Trend of the change of the value of CNY for 3 months
Figure 8: Trend of the change of the value of CNY for half a year
From the data in one-month trend, we can find that, the whole trend of the value of CNY
decreases(compared to EUR), at the same time, there were three sharp changes during

16
September 5-9, 15-17,20-22, when the highest exchange rate in this month was about 7.5150
CNY/EUR, and the lowest one was about 7.4400 CNY/EUR.
From the data in three-month trend, the whole trend of the value of CNY decreased a
lot(compared to EUR), especially during August 15 -August 20, the exchange rate changed
from about 7.4000 CNY/EUR to about 7.5250 CNY/EUR.
Next, an example is used to show how we will use the spot market and forward market.
2015.6.1, FinnMilk Oy Finland company export to China, receive a three-month forward
draft for CNY 25,000,000. In that time, EUR/CNY=7.40. But we were afraid of EUR
appreciation after three months.
Spot market Forward market
6.1 receive CNY forward draft 25,000,000.
EUR/CNY=7.40
Value 25,000,000/7.40=3,378,400EUR
sell a forward contract maturity at Sep
valued 25,000,000CNY
Forward price 1CNY=0.1352EUR
Contract value
25,000,000*0.1352=3,380,000EUR
9.1 Forward draft sold 25,000,000 CNY
EUR/CNY=7.50
Value 25,000,000/7.50=3,333,300EUR
Buy a forward contract maturity at Sep
valued 25,000,000CNY
Forward price 1CNY=0.1323EUR
Contract value
25,000,000*0.1323=3,307,500EUR
Loss 45,100EUR Profit 72,500 EUR

17
Section 4: Monitoring Movements in the Foreign Currency's Value
The key factors that may influence the value of the foreign currency (CNY) we use will be:
1. Inflation: Changes in inflation rates can influence the demand for and supply for currencies
and the value of currency. For example, if China inflation rate suddenly increase, the demand
for the goods and products will increase and then, will much bigger than the supply of the
products. Then, the products will have higher price, it means that, we need more money to
buy the same products, from this perspective, the value of the CNY depreciates.
2. National income: If China’s income level increases by a higher percentage than those of
other countries, CNY are expected to decrease because when the income level increases, the
consumption of goods will also increase, then it’s likely that Chinese people’s demands for
foreign goods will increase.
3. Government restrictions: Chinese government can make decisions on many aspects of
trades. Some of these policies maybe will influence the value of CNY directly or indirectly.
For example, if the government placed a heavy tax on interest income earned from foreign
investments, this will make the exchange rate of CNY to foreign countries’ currency to
decrease.
4. Trade deficit or surplus: If China experiences a balance of trade surplus for a long time, it
will place upward pressure on the value of CNY. Because when there appears trade surplus, it
means that the demand for this kind of currency of the international market is more than the
supply of this country’s currency, which will make the value of this kind of currency to
increase.
5. Interest rate: The interest rates will have an influence on the direction of the currency flow.
If this country has a higher interest rate than that of the other country, this will encourage the
currency from international market to get into Chinese market while discouraging the CNY to
get out from China, which will make the value of CNY to increase.

18
6. International environment: The appreciation in the value of CNY in this year is partly the
result of the situation in the international market. Some countries will hope CNY to
appreciate, in this way, there will be less Chinese products enter their markets, and also, the
other currency will depreciate, as a result, those countries’ export products can be more
competitive.
7. Exchange rate system: The adoption of different kinds of exchange rate systems will
influence the value of the currency. For example, if a country adopted a fixed exchange rate
system, in the process of development, it will always face the possibilities that the
government will devalue or revalue its currency.

19
Section 5: Using Currency Futures and Options
1. As FinnMilk Oy will initially export infant milk powder (Finnimi) to the Chinese market,
the determination of exchange rates between euro and Yuan is relevant here. Because the
company will receive Yuan mostly in exchange for milk powder supplies and the rate at
which Yuan will be received depends on the future spot rate or forward rate. If this is the
case, the company has to be forecasted that whether the value of euro will be appreciated or
depreciated in the near future. If euro is depreciated, the receivables of Yuan will produce
fewer Euros, which bring loss for the firm. Therefore, the use of hedging techniques to
insulate from exchange rate exposures is significant.
FinnMilk Oy, based in Finland, exports milk powder to the Chinese distributors or retailers
and will receive payment of 500,000 Yuan in next three months. As of October 19, 2016 the
spot rate is CNY1: €0.1352 (yahoo finance). It is indicating that Euro is depreciating against
CNY at the moment by 0.0110%. The firm also expects that euro would be depreciated
further against CNY based on historical analysis. If it happens, the company’s receivables of
500,000 Yuan would produce more Euros because strengthened CNY would buy more
weakened Euros, if converted. However, the company negotiates with local brokers a 90-day
future contract from now to sell 0.5million Yuan at a future date, January 2017. Remember
that it is better for FinnMilk Oy if CNY appreciates against Euro. The currency future rate is
quoted at CNY1: €0.13401 on that date (CNY/EUR futures, CME Group).ii
CNY has
appreciated during this time by 0.008883%.
The company has negotiated a 90-day future contract from now with a local broker to
exchange 500,000 Yuan for euro at € 1.1255. In three months, the company will exchange its
500,000 Yuan for €562,750 (computed as 500,000 Yuan×€1.1255=€562,750). Thus, the
company will sell 90-day future contract and receive that amount upon the settlement date on
December.

20
2. Currency options are used by MNCs to purchase or sell a particular currency at specified
price (strike or exercise price) on a specific settlement date (exercise date) in case of
European options.
As FinnMilk Oy initially exports infant milk powder (Finnimi) to the Chinese distributors, it
would receive payment in Chinese currency, Yuan. If Yuan is expected to depreciate in
future, the company would face a big loss. Therefore, the company wants to minimize its
exchange rate risk exposure by purchasing a currency put option that serves the right to sell a
particular currency (CNY) at a particular price on the settlement date. This allows the
company to exercise the contract only if the spot rate is less than the strike rate or can set a
minimum rate at which it can exchange CNY for Euros. However, if the Yuan appreciates
over the time period, the company can let the put options expire and sell the Chinese Yuan it
receives at the prevailing spot rate.
As of October 19, 2016 the spot rate is CNY 7.3952:€1 (yahoo finance). FinnMilk Oy buys
put option if CNY is expected to depreciate. The strike rate for 3 month currency put option
is €1.20000. It indicates that CNY is expected to appreciate in 3 month period. Therefore, if
it happens, the company can cancel the put option and sell CNY at the prevailing spot rate.
Once FinnMilk Oy establishes its subsidiary, it also needs to buy CNY to finance the
subsidiary’s operation. At this time, the strengthened CNY requires more Euros to finance the
operation, which is expensive to the parent company. Thus, FinnMilk Oy has to pursue
currency call options that allow buying certain amount of CNY at certain price (strike rate). If
the spot rate is greater than the strike rate, the company can execute the currency call option.

21
Section 6: Monitoring Central Bank Intervention
1. If the European Central Bank (ECB) attempts to appreciate the Euro in the foreign
exchange market, it’s true that the value of any economic entities like FinnMilk Oy will be
changed proportionately with the changes done. However, the ECB can accomplish this
objective to purchase Euros directly from the foreign exchange market by selling their
foreign currencies reserves to this market and thereby, putting upward pressure on the value
of the Euro. If the ECB does so without adjusting for the change in the money supply it is
engaged in non-sterilized intervention.
As the value of the Euro has been appreciated by the ECB, this will affect the company’s
exports, meaning that Chinese customers will find Finnimi brand costlier because now a
greater number of Chinese Yuan are required to buy one unit of the Euro currency. As a
result, at least in the short run exporting infant milk powder to the Chinese market might be
unfavorably affected. In other words, sales in china would be affected until adjusted. Even
though Chinese consumers will find infant milk powder expensive due to the revaluation of
the euro, the actual price of the product remain unchanged to the Finnish consumers. Besides,
businesses that import raw materials from china would take advantage of euro revaluation
because they can exchange their Euros for more Chinese Yuan until adjustments made by
market forces. Therefore, this appreciation of euro by the ECB would affect the company’s
cash inflows in the short run.
Economic exposures play a great role here. Assuming that Euro has appreciated, home
customers will find foreign substitute products cheaper than home products because products’
price denominated in weakened foreign currency is more attractive than those of home. If this
is the case, FinnMilk Oy would find its domestic sales to decline to some extent because
other infant milk powders may act as substitute instead of Finnimi brand. Therefore, if the
ECB revalues Euro, both home and foreign sales of FinnMilk Oy might be unfavorably
affected.
In turn, businesses like FinnMilk Oy would be implementing cost-cutting strategies by which
would create unemployment and reduce the country’s national income level.

22
2. If the ECB attempts to weaken the Euro, it can do so by directly exchanging euros that it
holds as reserves for other foreign currencies in the foreign exchange market and thus,
putting downward pressure on the value of the euro. If the ECB does so without adjusting for
the change in the money supply it is engaged in sterilized intervention.
As FinnMilk Oy exports Finnimi to distributors or retailers in China, devaluation of euro by
the ECB creates more demand for euro, which reflects Chinese imports would be
substantially increased. Because Chinese demand for infant milk powder will be increased,
they now see that a few numbers of Yuan are required to buy more Euros due to euro
devaluation. Therefore, the depreciation in the value of euro by the ECB brings some benefits
for the company in the short run.
3. FinnMilk Oy is adversely affected if the ECB indirectly intervene in the economy. In one
case, when foreign investors and companies mobilize their investments from Finland to
countries with high-yielding securities’, this typically places downward pressure on the value
of the Euro. At that time, the ECB would want to insulate the Euro value from not going too
far is by raising interest rates to a level that can attract and retain more foreign investments,
which in turn discourage excessive outflows of funds. However, the resulting higher interest
rates may adversely affect local businesses/borrowers such as FinnMilk Oy because the cost
of obtaining fund is higher in the local market, which eventually reduce the economic growth
locally.
The higher cost of fund shrinks the value maximization goal of the company as the net
expected cash flows generating from the company will be discounted at a higher rate (factor)
that result in less or negative net present value (NPV). Moreover, our shareholders bearing
much financial risks due to higher interest rates would make the business more risky and
thereby, demanding a higher required rate of return. Therefore, the supreme goal of the
company’s value maximization will be inversed by the increased interest rates in the
European economy.

23
Section 7: Assessing Spot and Forward Rates
1. Euro 1: Yuan 7.4154. (Bank of China 2016).
Euro 1: Yuan 7.4007. (Industrial & Commercial Bank of China 2016).
No, the spot rates vary slightly across locations at a given point in time.
2. The one-year forward rate of Eurozone Euro and Chinese Yuan (EUR/CNY) is 1:7.5931.
(Kunlun Financial Network 2016). Prevailing one-year interest rate in the Euro area is 0%,
while one-year interest rate in China is 4.35%. (Trading Economics 2016). Given the
differentials, interest rate parity does not exist.
3. One year forward rate of Euro and Yuan from another source is 1:7.5960 (HSBC). There is
a premium in the forward rate of both currencies.
No, interest rate is not the only factor affecting the Euro-Chinese Yuan exchange rate. Rather,
it is being highly influenced by factors such as market forces, inflation, government control,
and others. As a result, these dynamics dictates the value of our host country currency and not
solely dependent on interest rate.

24
Section 8: Determining Whether IFE Holds
Interest rate differentials between China and the Eurozone from 1.7.2015 to 30.9.2016 are
shown below.
Table 2: Interest rate differentials of China and Euro area.
Quarters China Euro Area Differentials
(%)
1 5.1% 4.75% 0.35%
2 4.6% 4.75% -0.15%
3 4.35% 4.75% 0.4%
4 4.35% 0% 4.35%
5 4.35% 0% 4.35%
The above table was drafted according to information available on Trading Economics and
Quandl web pages. As seen exhibited on the table, the various quarters exhibited interest
differentials of 0.35%, -0.15%, -0.4%, 4.35% and 4.35% in that order.

25
Percentage change in Euro, Chinese Yuan exchange rates from 1.7.2015 to 30.9.2016
Figure 9: Exchange rates of Euro and Yuan from July 2015 to September 2016. (USForex
2016).
Given the above figure, the percentage change would be:
Table 3: Percentage change in exchange rates of Euro and Yuan.
Quarters Rate Change (%)
1 (7 – 9, 2015) 7.1565 – 6.7763/6.7763 5.60%
2 (10 – 12, 2015) 7.0864 – 6.9648/6.9648 1.75%
3 (1 – 3, 2016) 7.3188 – 7.1226/7.1226 2.75%
4 (4 – 6, 2016) 7.3751 – 7.4044/7.4044 0.40%
5 (7 – 9, 2016) 7.4732 – 7.4173/7.4173 0.75%
Percentage change between the exchange rate of Euro and Yuan in the last five quarters is
5.60%, 1.75%, 2.75%, 0.40% and 0.75% respectively as shown on the table above. (USForex
2016). Given this statistics, the international Fisher effect does not hold.

26
Section 9: Monitoring Exchange Rate Trends
Figure 10: EUR/CNY. Long-term. Exchange rate changes from 2007 till 2017 (Investing.com
2016)
If we talking about long-term tendency (period from 2007 till 2017), EUR/CNY is
depreciating from 10,1349 in 2007 to 7,4005 in 2017 with a change in 2.7344 (-26,98%).
Table 4: EUR/CNY. Short-term. Exchange rate changes from 01.01.2014 till 16.10.2016
(nowdays), every 5 weeks. (Investing.com 2016)
Date Exchange rate Changes
16.10.2016 7,4019 -0,0439
11.09.2016 7,4458 0,0401
07.08.2016 7,4057 0,0124
03.07.2016 7,3933 -0,069
29.05.2016 7,4623 0,0456
24.04.2016 7,4167 0,1409

27
20.03.2016 7,2758 0,0135
14.02.2016 7,2623 0,0736
10.01.2016 7,1887 0,0946
06.12.2015 7,0941 0,2703
01.11.2015 6,8238 -0,301
27.09.2015 7,1248 -0,0173
23.08.2015 7,1421 0,3215
19.07.2015 6,8206 -0,229
14.06.2015 7,0496 -0,0579
10.05.2015 7,1075 0,524
05.04.2015 6,5835 -0,2079
01.03.2015 6,7914 -0,2639
25.01.2015 7,0553 -0,5099
21.12.2014 7,5652 -0,0239
16.11.2014 7,5891 -0,2266
12.10.2014 7,8157 -0,1378
07.09.2014 7,9535 -0,3026
03.08.2014 8,2561 -0,1786
29.06.2014 8,4347 -0,0818
25.05.2014 8,5165 -0,1342
20.04.2014 8,6507 0,0642
16.03.2014 8,5865 0,2794
09.02.2014 8,3071 0,0342
05.01.2014 8,2729 0

28
Figure 11: Graphical analysis of exchange rate changes from 01.01.2014 till 16.10.2016
(Investing.com 2016)
But in a period of last two years currency of EURO is depreciating with maximum spot in
8,6801 (April 2016) and minimum in 6,6527 (March 2015).
But from 2015 exchange rate of EURO/CNY shows mostly only positive growth with current
exchange rate of 7,4019 Chinese yuan per 1 euro.
The reason why CNY depreciates is too high interest rates in China in yuan. Dollar became
more attractive for Chinese corporate borrowers, which had taken loans in offshore markets.
2 years ago a dollar loans were incredible profitable and were considered quite safe and
predictable – people take the cheap loans in dollars and invest the money in a much more
perspective Chinese asset in terms of profitability. Now they return their debts. (The
Financial Times, February 2016).
With provided data above FinnMilk Oy strongly believe in continued tendency with
appreciate of EURO that presumes big opportunities for penetrating Chinese market.

29
Section 10: Recognizing Exposure to Exchange Rate Risk
1. Effect of depreciation in the exchange rate.
A depreciation will make exports cheaper and FinnMilk will benefit.
Increase profit margin or reduce foreign price. In that case FinnMilk has a choice to reduce
Euro price and this would lead to an increase in the quantity sold, and increase Finnish
exports. Or other choice - keep the same price and just make a bigger profit margin
Impact of an appreciation. If there is an appreciation in the value of the Euro the impact will
be:
Exports will be more expensive. This will lead to lower demand for Finnish exports or the
company will have to reduce their profit margin.
2. There are three types of foreign exchange exposure risk a multinational will encounter
when it invest in foreign markets. They are:
Economic Exposure.
Economic exposure is also known as long term cash flow exposure. A multinational buys and
sells goods and services around the world and due to the volatility of the foreign currencies it
will post a threat to the receipts and payments of those transactions. (How Multinational
Treasurers hedge their Foreign Exchange Exposure in Global Operations, Sam Chee Kong).
FinnMilk Oy doesn’t face this kind of risk. The company is established in Finland and uses
only local source materials.
Transaction exposure.
Transaction exposure involves short term cash flow denominated in foreign currencies due to
a sale of goods or services. Whenever a firm had receivables or payables denominated in
foreign currencies, then the firms cash flow denoted in local currency will fluctuates. The
following are some forms of transaction exposures:
Purchasing of goods and services on credit denominated in Chinese currencies.
Borrowing and lending of funds denominated in Chinese yuan.

30
Translation Exposure.
Translation exposure is concerned with a company’s assets and liabilities denominated in
foreign currencies or its plant, machineries, debts, loans, lands and buildings or any other
items that is related to its Balance Sheets. (How Multinational Treasurers hedge their Foreign
Exchange Exposure in Global Operations, Sam Chee Kong 2012).
All its plants, machineries, lands, receivables, payables, loans and so on will be recorded in
the currencies of China that we are going to operating in. To consolidate its accounts in
Finland, FinnMilk will need to translate their accounts to Euro. As a result there exists a
translation exposure due to the changes in the foreign currencies.

31
Section 11: Denominating Receivables in Euro
How a switch from Yuan to euro will affect the transaction and economic exposure of our
business:
A switch in pricing policy from the Chinese Yuan to Eurozone Euro in the host country of
our subsidiary will not necessarily expose us to transaction risk because that will guarantee us
more stability in pricing and eliminates the need to convert currencies. However, demand for
our product is threatened. The basic analogy behind this is the fact that Euro is a stronger
currency than the Yuan, in that sense, it will appear too high for the host country customers.
Consequently, they will turn to other options, preferably cheap locally made alternatives,
which wards off or significantly reduces our brand equity in the market and eventually leads
to overall economic exposure of FinnMilk Oy.
Conditions that could still cause the performance of our business to be affected by exchange
rate movements are:
Inflation: For us the recurring inflation resulting from export and import balance in China is a
major concern. Prices of goods are unlikely to be stable due to the constant exchange rate
movements that will emanate from this development.
Government intervention: Due to the exchange rate system in practice in the host country of
our foreign subsidiary, the activity of the government in opting in to make changes when
occasion calls for it will certainly have impact on the performance of our business. This
means that we have to keep close tab on the movements of the exchange rate to make
decisions that may either impart the business positively or otherwise.
Currency value of other countries: The value of competing economies, developing and under-
developed countries could relatively expose us economically. For instance, a rival economy
like US may decide to devalue their currency to attract more customers to the US market,
while the currencies of some developing and under-developed countries are automatically
free-floating negatively. If FinnMilk’s products turns out to cost more than the alternatives in
US, the importers from these countries will switch to the US market because it costs less.

32
Section 12: Establishing a Subsidiary in Foreign Country
Reasons why it may be feasible to establish small subsidiary in China
Increased Demand for Imported Milk: The information gathered from the Chinese market
regarding powder milk as earlier recorded in this report, centers on demand for imported
alternatives. The top three selling powder milk in the Chinese market are imported into the
country. The reason for this is that the consumers are opting for quality over price and
quantity. We intend to capitalize on this opportunity. Keith Woodford in his report “China
dominates global dairy imports” in May 2016 further buttressed this finding.
Leading market: China today is practically the largest economy in the world with a
significant population to go with it. This makes it feasible because business thrives when
there are potential patronage and population.
Operating Cost: With abundance of well-trained human resources in the Chinese labor
market, it will be ideal to establish a subsidiary in China to reduce cost of operation and
improve profit margin. Literally, owning a subsidiary in China lessens expenses related to
exporting, agency fee, labor and the overall operating cost in China.
Favorable political environment: The Chinese political environment also favors the
indoctrination of foreign investors in the country. The Chinese government while
emphasizing that they are committed to their policy of accommodating foreign investors also
stated that it is willing to maneuver when necessary to for economy uplift. (The State Council
2016).
Explore New Markets Opportunities: China has turned out to be the highest exporting
country in the world. How does this serve as opportunity for us? Since China is a large
market that exports to many countries, establishing a daughter company in China means
expanding our business further beyond the Eurozone and China. What this means is that it
presents us avenue to tap into neighboring markets in the Asian region and this translates to
more cash inflows.

33
Rapidly increasing consumer wealth: Reports have shown that due to the economic boom
China is enjoying, the purchasing power of the populace is also strengthening. The basic
analogy here is, people spend more when they earn more. (David Scutt 2015).
Disadvantages associated with establishing a small subsidiary in China
Counterfeit products: There is every tendency that FinnMilk’s product will be mass-
counterfeited, given the norm in China. Though the government is working relentlessly to
clamp down on the perpetrators, it remains a major concern for investors.
Exchange rate risk: China makes use of managed float exchange rate system; consequently,
the central bank of China may intervene at a time we are not prepared for such change to
devalue the currency. This will expose us to translation risk if we have dire need for it at the
time of concern.
Rising inflation risk: Due to the large business activities in China, the export is consistently
above the imports. When national income exceeds revenue with a significant margin like the
case in China, the result is inflation. An article on Trading Economics reported that consumer
prices rose by 1.3% in August, 2016 in contrast with the previous year. This will affect the
stability of our pricing and business in general. (Trading Economics 2016).
Stiff competition: Contending with the fully established brands in the market means that
Finnmilk have to do more than just opening a subsidiary but spend more on commercials and
possibly social responsibilities to place a stake in the market. It could go either way, we may
end up spending without reaping the intended profit of the cause.
Increased workload: The additional decision making, tax and extra-legal activities that comes
with foreign owned subsidiary can be cumbersome.

34
Section 13: Deriving Required Rate of Return for an International Project
1. Assume that due to the boost growth level of Finnimi in the Chinese market, FinnMilk Oy
has been planning to build a small subsidiary in china in order to expand its business horizon.
From the financial perspective, establishing a small subsidiary in a foreign country (China)
requires an initial investment. The investment and finance managers of the company are
considering every aspect in order to understand that the proposed project would create or
maximize value for the company.
In order to maximize shareholders’ value, FinnMilk Oy well knows that it has to come up
with an optimal capital structure that minimizes the cost of capital, in other words, the price
of the initial investment or the required rate of return. Thus, the company’s capital structure
decisions with regard to the proposed subsidiary establishment rely on how it is going to
finance this operation in china. As the company is inexperienced in international business, it
is thinking to employ both debt and equity capital to finance its proposed project.
The following discussion relates that the cost of capital or the market required rate of return
for the proposed project (subsidiary) depends on what proportion (mixture) of debt and equity
capital employed in the subsidiary’s capital structure (see section 16 for details). Therefore,
FinnMilk Oy briefly addresses its project’s capital structure below.
Step 1
Assume that FinnMilk Oy has been currently adopting long-term capital structure ratio:
equity 70% and debt 30%. However, the company now would like to build a new capital
structure for its proposed subsidiary based on the riskiness of the project, that is, 60% equity
which comes from the retained earnings accumulated over time by the parent (FinnMilk Oy)
and 40% debt which would be financed by the China-based subsidiary. There are two options
that the subsidiary can do either by
i. borrowing money from the local Chinese banks, that is,
corporate loans; or
ii. issuing corporate bonds denominated in RNB on a long-
term basis in the Chinese Bond market.

35
The company also considers these two options for debt capital because the proposed
subsidiary either borrows from local banks or issues corporate bonds are not exposed to
exchange rate exposure while currency conversion. The company’s accumulated retained
earnings may be unfavorably affected by exchange rate risks if the Chinese Yuan appreciates
at that time.
Step 2
Assume that though the 40% debt capital would be financed by the subsidiary, the parent
company (FinnMilk Oy) looks after and controls the financing decision. Therefore, if
FinnMilk Oy pursues the first option for debt financing, the company thinks that it has to
look for the interest rates of corporate loans in China. Different Chinese commercial banks
have same interest rates because People’s Bank of China determines the market interest rates
for all banks in China.
Table 5: Short-Term & Long-Term Loan Rates in China
Commercial Banks IR (1 year or less) IR (1 to 5 year)
1. Bank of China 4.35% 4.75%
2. Agriculture Bank of China 4.35% 4.75%
3. ICBC 4.35% 4.75%
Note that the loan rate offered by different commercial banks is almost same. The finance
manager of the company estimates that the cost of debt is the average lending rate (depending
on the short-term and long-term) of all banks at which they can disburse loans.
However, if FinnMilk Oy pursues that the subsidiary would issue corporate bonds in China;
the company has to look for the Chinese risk free Treasury bond rate with the same maturity
level as the project is. The risk free rate of Chinese Treasury bond with a maturity of 1-year
and 10-year is 2.1381% and 2.6952% respectively.
Moreover, the risk premium on the issued bond depends how risky the proposed project is
based on credit ratings, default risks, maturities, yields etc. to the creditholders. FinnMilk Oy
could get estimates of bond’s yield issued by other foreign companies’ in the same industry.
Several European MNCs have established subsidiaries in China, including Danone, a France
food giant, established Dumex, a subsidiary that produces infant milk powder. In this case,

36
FinnMilk Oy can use Dumex’s cost of debt in order to adjust its estimated cost of debt, for
example. Apart from this, FinnMilk Oy can pursue competitors’ cost of debt that the
company can use based on market values because they are in the same industry with same
risk levels.
Step 3
Assume that FinnMilk Oy is privately owned equity company. However, in Finland, it has
also been financing its operations by obtaining private equity funds, venture capital and so
forth on the market because equity financing in the euro zone facilitates firms to obtain funds
at low cost. In the case of 60% equity financing by the parent to its proposed subsidiary, the
parent company would capitalize its accumulated retained earnings of its shareholders’ who
want a return from the proposed project similar to the return they can obtain if invested in the
company or other projects/securities based on the same risk level. Similarly, according to the
CAPM model, the riskiness of its proposed project is determined by the project specific beta
by which risk premium can be calculated. Therefore, the cost of equity equals the risk-free
rate of treasury securities (same maturity level) plus the risk premium. Note that the risk-free
rate of treasury securities can be obtained from HSE.
Step 4
Once the company knows its kd , given the tax rate of 25% (CIT of PRC on Foreign
Enterprises) upon diary industry in china, the after tax cost of debt can be calculated easily.
Step 5
Now FinnMilk Oy has been estimated all the components of its cost of capital. The financial
manager of the company can determine the weighted average cost of capital by putting slice
of debt and equity in the pie along with their respective costs. Note that the weighted average
cost of capital is called the market required rate of return that FinnMilk Oy must generate to
satisfy its stakeholders.
It would be better gauge if FinnMilk Oy looks at the cost of capital of other foreign
companies’ doing business in the same industry in China and then adjusts its cost of capital.

37
Section 14: Estimating Cash Flows of an International Project
1. As FinnMilk Oy is considering an expansion by establishing subsidiary in china, the
company has to be ascertained that how it could derive benefits from this project in response
to the costs incurred. Like any corporations, the main goal of FinnMilk Oy is to maximize
shareholders’ wealth. NPV is often used as an indicator of shareholders’ wealth
maximization. Therefore, the costs and benefits associated with the proposed project reflect
in the project’s NPV.
The company is attempting to outweigh benefits over costs so that it can add value in the
shareholders’ investment. For this, FinnMilk Oy has to forecast net expected cash flows
throughout the lifespan of the proposed project. In order to forecast the expected cash flows,
on top of that, the firm has to estimate future demand for Finnimi on yearly basis and
inflation rate that causes change in prices and costs too.
Once the company calculates its net expected cash flows, it has to pay withholding tax 5/10%
on remitted earnings to the parent. Then the earnings need to be converted to the prevailing
exchange rate, CNY against euro. If CNY depreciates suddenly against euro, the remitted
earnings by the subsidiary would be unfavorably affected by such depreciation because
weakened CNY will buy fewer strengthened Euros. Therefore, business revenues are
adversely affected by exchange rate movements.
In addition, net cash flow received by FinnMilk Oy can be estimated by using different
scenarios, by altering a particular variable in order to realize how sensitive the variable is in
relation to cash flows and thus, the NPV. The more sensitive a particular variable is, the
higher probability that the company’s cash flow will change. Therefore, the variability in net
expected cash flows cause the company’s NPV to change which in turn affect the parent
expected revenues.
Assume that FinnMilk Oy is planning to liquidate its subsidiary or merge with another
Chinese company after 5 years. The company can estimate the future cash flows based on
market demand and the salvage value when it would be sold. Each year the company would
receive cash inflows denominated in CNY and subsequently, it would also receive the

38
liquidation value. The NPV is calculated as summing all future cash flows plus salvage value
discounted by the required rate of return. If NPV>0, the company can generate positive NPV.
2. FinnMilk Oy must also estimate the associated expenses in establishing subsidiary in
China. Here the expenses are presumed to be incurred directly or indirectly only for the
subsidiary the company is going to establish.
Apart from the expenditure of capital budgeting analysis, FinnMilk Oy has to consider the
expenditures related to the production and marketing of its product. Both the production and
marketing department is responsible for fixing product price on the basis of competitors’
pricing policies, material costs, labor cost, production cost and so forth. The company can
look into foreign competitors such as Fonterra NZ, Dunone France etc. in order to get idea
about international pricing and quality measures.
The company’s fixed costs include office rent, equipment, employees’ salary, advertising and
so on. It estimates that equipment and tools would be depreciated on straight-line method and
depreciation as cash inflow would be deducted according to the accounting principle.
As the company plans to borrow long-term debt capital for its Chinese subsidiary, it would
have to pay periodic interest payments. This interest payment will be subtracted before
calculating corporate tax. This is beneficial for the company because it initially have to pay
less tax on its income.
Other macroeconomic factors such as interest rates, inflation, exchange rates, government
controls and so on are indirectly affect the company’s cost structure. For example, because of
government restrictions and regulatory measures on the diary industry in china, it has
seriously affected foreign diary companies. It has also increased the cost of production and
other legal costs. The melamine scandal in China (2008) was the main issue from when the
Chinese government placed high restrictions in the dairy industry such as foreign dairy
companies are required to screen their products’ quality through registering at China’s
General Administration of Quality Supervision, Inspection and Quarantine. Therefore,
FinnMilk Oy has to take into account these economic and political factors while estimating
its expenses of the proposed subsidiary.

39
3. The production and sale of Finnimi through the subsidiary in the Chinese market requires
initial investment made by shareholders. However, shareholders require periodic expected
cash flows which the company has to estimate in order to make an informed decision.
The finance manager of FinnMilk Oy is responsible for forecasting future cash flows which
the parent company is expected to receive at the end of each period. However, the subsidiary
manager points out that expected cash flows per year largely depend on the sales volume on
that year and other economic factors. Besides, the cash flows are exposed to exchange rate
risks while remitting back to the parent.
Once the company’s subsidiary has computed operating income (total revenues-total
expenses), it has to leave 25% of its income as business tax. The after-tax income of the
company with its depreciation expense is added to compute the incremental operating cash
flows each year. However, the net expected cash flows are sensitive with any changes
occurred thereafter. This might be one of the ways how FinnMilk Oy can estimate its cash
flows.
4. FinnMilk Oy can estimate net expected cash flows that might be overestimated for many
reasons. The company’s managers normally forecast the future cash flows based on various
factors (variables) the company would generate and receive at the end of certain period. Any
changes of these variables thereafter could overestimate or underestimate the expected cash
flows.
Generally the company’s net cash flows are calculated as its total revenues minus total costs
minus taxes. These key three factors depend on other variables. For example, total revenues
and total costs are the function of demand, price and administrative expenses, advertising
expenses, fixed expenses etc. respectively. Any changes in inflation affect these variables to
change and thus, the estimated expected cash flows. Often the company’s managers make
estimation matrix to coordinate their forecasting across the departments. The matrix can be
shown below as an example.

40
Table 6: Estimation Matrix
f(variables) 1
(least
likely
)
2
(less
likely
)
3
(stable
)
4
(more
likely
)
5
(most
likely)
Demand √
Price √
Fixed Costs √
Variable Costs √
Tax √
For instance, the managers of FinnMilk Oy forecast five year expected cash flows based on
these variables. They mainly estimate on the basis of best possible occurrences, however, the
actual cash flows (outcome) after five years might be lesser to some extent than the expected
cash flows. Therefore, in this way the company might overestimate its future cash flows.

41
Section 15: Assessing Exposure to Country Risk
Financial Risk Factors
Indicators of Economic Growth
Table 6: Economic Indicators of China (Trading Economics 2016)
The Chinese economy experienced astonishing growth in the last few decades that catapulted
the country to become the world's second largest economy. In 1978—when China started the
program of economic reforms—the country ranked ninth in nominal gross domestic product
(GDP) with USD 214 billion; 35 years later it jumped up to second place with a nominal
GDP of USD 9.2 trillion.
Since the introduction of the economic reforms in 1978, China has become the world’s
manufacturing hub, where the secondary sector (comprising industry and construction)
represented the largest share of GDP. However, in recent years, China’s modernization
propelled the tertiary sector and, in 2013, it became the largest category of GDP with a share
of 46.1%, while the secondary sector still accounted for a sizeable 45.0% of the country’s
total output. Meanwhile, the primary sector’s weight in GDP has shrunk dramatically since
the country opened to the world.
China weathered the global economic crisis better than most other countries. In November
2008, the State Council unveiled a CNY 4.0 trillion (USD 585 billion) stimulus package in an
attempt to shield the country from the worst effects of the financial crisis. The massive
stimulus program fuelled economic growth mostly through massive investment projects,

42
which triggered concerns that the country could have been building up asset bubbles,
overinvestment and excess capacity in some industries. Given the solid fiscal position of the
government, the stimulus measures did not derail China’s public finances. The global
downturn and the subsequent slowdown in demand did, however, severely affect the external
sector and the current account surplus has continuously diminished since the financial crisis.
Apparently, China exited the financial crisis in good shape, with GDP growing above 9%,
low inflation and a sound fiscal position. However, the policies implemented during the crisis
to foster economic growth exacerbated the country’s macroeconomic imbalances.
Particularly, the stimulus program bolstered investment, while households’ consumption
remained repressed. In order to tackle these imbalances, the new administration of President
Xi Jinping and Premier Li Keqiang started to unveil economic measures aimed at promoting
a more balanced economic model at the expense of the once-sacred rapid economic growth.
Political Risk Factors
China is particularly hazardous with respect to political risk. The possibility of
nationalization of industries needs to be considered. In fact this has already occurred in China
(in 1949). Similarly, there are the risks of confiscation, expropriation, currency
inconvertibility and contract repudiation. Currency devaluation and rampant inflation are
possible scenarios in many countries, wreaking havoc on the adequacy of insurance limits, as
one of many potential problems. There is also risk to company employees of personal harm
or kidnapping, and risk to the firm of extortion attempts. A unique form of political risk
occurs in China, and this is the constant battle between the country’s central government and
the provincial and local governments over applicable law, and observance or non-observance
of it. This makes it difficult for companies operating in China to know exactly what the rules
are (China Political Risk Management, 2009).
i. Attitude of Consumers in the Host Country
Preferences and behaviors of Chinese consumers are becoming increasingly complex. Non-
price factors such as brand are becoming more and more important in purchasing process.
Consumers are led to the high quality of imported products, good service and valuable brand.

43
In addition, growing consumer personality reflected in their purchase choices, because the
people seek to stand out of the crews. (Roland Berger Strategy Consultants 2010.)
In specific industries, brand is the most important factor when making a purchase. Quality is
also increasingly aware among Chinese consumers, especially the quality defect exposed as
the threat to public health and safety. While the price is no longer in the first place, however,
value for money is also an important factor affecting the Chinese consumer choices and they
are willing to pay more for better quality and services. (Roland Berger Strategy Consultants
2010.)
Families are the social groups most closely related with traditional Chinese culture, since the
one-child policy implementation carried out by the Chinese government, the later generation
has been influencing the market revolution and leading a great leap forward to the
consumption of children products. The parents and grandparents in China focus on striving to
provide the later generation a better life than the one they experienced. The one-child policy
also increases the Chinese families’ disposable income and ensures that the resources would
be focused on a single child instead of many, for the elder generations to invest heavily in
their single child for their growth and development. (Appalachian State University 2012.)
ii. Actions of Host Government
In recent years, the controversies about fake foreign milk powder in the market continue to
cause heated debate. The so-called fake foreign milk powder is the domestic milk powder
enterprises registered brand in foreign countries, and then commissioned by the factory OEM
milk production, and some in this way the production of milk powder in the foreign market is
not sold.
China has begun to strictly limit the infant formula milk powder importer, as a domestic dairy
industry to restore domestic market share as part of the effort. Prior to this, the importer has
been using Chinese nationals desire for foreign brands milk profit. In this case. In 2013 the
United States Su Li false foreign milk incident exposure, foreign milk powder in the Chinese
market myth position began to crack. Followed by the market on the "Chinese market
Bacheng imported milk powder brand for false foreign milk," the news story is worn uproar.

44
In order to rectify the import milk powder market, May 20, 2013, by the State Food and Drug
Administration, Ministry of Industry and Information Technology, Ministry of Public
Security, Ministry of Agriculture, Ministry of Commerce, Health and Family Planning
Commission, General Administration of Customs, Administration of Industry and
Commerce, AQSIQ 9 ministries and co-sponsored the "strengthening of infant formula milk
powder quality and safety of working media forum" on the scene, the official release "on
further strengthening infant milk powder quality and safety of the views of opinions" clearly
pointed out that "any enterprise shall To commission, OEM, packaging production infant
formula milk powder. "
Subsequently, the State General Administration of Quality Supervision, Inspection and
Quarantine of the People's Republic of China, the State General Administration of Quality
Supervision, Inspection and Quarantine of the People's Republic of China, the State
Administration of Quality Supervision, Inspection and Quarantine of the People's Republic of
China.(China Baby Network 2016).
iii. Currency Inconvertibility
On November 30, 2015, the Executive Board of the International Monetary Fund decided to
include the yuan in the SDR basket of currencies. This marks the RMB internationalization
has crossed a new milestone.
There is no doubt that this will further enhance the international status of the RMB, China
will also improve the global trading rules to develop the right to speak. There are currently
four SDR currency baskets, namely the US Dollar, Euro, British Pound and Japanese Yen. As
the first currency from developing countries, the RMB "basket" is of great significance.
From a macro perspective, China is the world's second largest economy, the global influence
is pivotal. With the development perspective, the Chinese economy and the world economy
gradually integrated into the international market for the RMB for international trade
settlement, financial product pricing and as a reserve currency demand gradually improved.
As the world's fifth largest trading nation, China's importance in world trade and the global
financial system has become increasingly apparent. The new round of China's opening to the
outside world has accelerated the cross-border RMB capital flow. With the strategy of "all the

45
way along the way" and the "going global" demand, the RMB settlement ratio will be further
increased, and large-scale cross-border investment financing and global scale Of the asset
allocation.(Sina column 2016)
iv. Stability
The level of foreign business activity in China after the Tiananmen Square massacre has
fallen off dramatically in many areas, including tourism and foreign investment. While
companies not already involved in China are wary of committing investment to China,
countries already involved in investment activities seemingly are waiting for a quiet period in
which economic progress will begin again and believe that China will not expel foreign
investors in the meantime. There is not much likelihood that extant joint ventures and foreign
manufacturing plants will be closed under the present regime, but political stability is still a
big question to foreign investors.
At the same time, China's economic growth and reform since 1978 has improved dramatically
the lives of hundreds of millions of Chinese, increased social mobility, and expanded the
scope of personal freedom. This has meant substantially greater freedom of travel,
employment opportunity, educational and cultural pursuits, job and housing choices, and
access to information. In recent years, China has also passed new criminal and civil laws that
provide additional safeguards to citizens. Village elections have been carried out in over 90%
of China's one million villages.
The United States has conducted 12 rounds of human rights dialogue with China since
Tiananmen. During 2003 and 2004, no progress was made on the commitments China made
at the 2002 dialogue, and we declined to schedule another round at that time. In February
2008, the United States and China agreed to resume our formal human rights dialogue, with
the understanding that the discussions need to be constructive. Outside the formal human
rights dialogue, the U.S. Government regularly raises human rights concerns with Chinese
officials at all levels of government. In his September 2007 meeting with President Hu and in
subsequent discussions, President Bush has emphasized U.S. interest in human rights and
religious freedom in China(Foreign Business in China responds to Political Instability, 1990).

46
v. Bureaucracy and Corruption
For the past three and a half years, China’s unprecedented high profile anti-corruption
campaign under President Xi Jinping’s leadership has drawn worldwide attention.
Domestically, Xi enjoys strong support from the general public, who have harboured deep
resentment against those “tigers” and “flies” whose embezzlement and bribery have done
enormous damage to social justice as well as the public interest.
The Chinese economy has entered a new era, with an expected (even planned) decrease in the
GDP growth rate, that is framed by the Chinese media as the “New Normal”. What is more,
as predicted by the World Bank, the Chinese economy will probably endure a further
downturn, with less than 7 percent in GDP growth in 2017 (see chart). Obviously, the year
2012, when President Xi came to power, was a watershed in terms of economic growth. In
2000-2012, the Chinese economy maintained an average annual growth rate of 10.2 percent
despite the financial tsunami in 2008. From 2012 onward, however, there has been a
significant dip, especially in the high-end service industry and its supportive segments. This,
as some pointed out, coincides with the massive anti-corruption campaign which was
launched in that year.
This argument may sound reasonable. Certain empirical studies show that “corruption” could
serve as “lubricant” of economic development, especially when the legal system lags behind
economic development driven by market forces. Thus, businessmen have to use bribery, or
“speedy money”, to bypass redundant administrative procedures and gain “fast pass”
privileges from officials in charge. With this “fast pass”, those who bribe can expand their
business without impediment. which helps to boost the growth. Following this logic, it is not
difficult to see why some pundits argue that the anti-corruption campaign has caused the
economic slowdown in China.
Indeed, as China is undergoing a socio-political transition, during which the institutional
construction of the legal system is still in progress, certain setbacks in economic development
in the wake of an anti-corruption campaign is inevitable. After all, corruption has created a
market for luxury services such as extravagant hotels, high-end resorts and restaurants that
are frequented in the name of hosting conferences, attracting investment, and providing
public goods. These industries have taken a heavy hit from the anti-corruption campaign. The

47
industries which support such services, such as catering and luxury gifts have also suffered as
a result of the domino effect. All of these factors have surely contributed to the economic
slowdown.
Nowadays, China is standing at a similar crossroads. For decades, Chinese privileged interest
groups have plundered uncountable natural and administrative resources at prices distorted in
their favor. As a result, these privileged interest groups have formed a high degree of
monopoly over resources and markets at the expenses of the public interest and social justice.
According to economic theory, a distorted market simply cannot optimize social welfare.
Only those privileged ones, consisting of corrupt government officials who take bribes, rotten
businessmen who make a windfall through monopolies as well as their family members and
associates, benefit from this system. The general public is deprived of not only their deserved
share of resources and wealth, but also the basic socio-economic justice that is the very basis
of the society. Thus, it is not surprising to see, in a corrupt environment, the lack of public
trust in government, selfishness and indifference in social behavior, and widespread
resentment and grievance in the society. Only by breaking through the monopoly by the
privileged interest groups can China truly establish an effective market mechanism under the
rule of law, which will eventually benefit the economy in the long run.(China Policy Institute:
Analysis 2015)

48
Section 16: Capital Structure Decisions
1. The cost of capital of any MNCs would be different from a domestic company due to its
greater access to international financial markets and so forth. In case of FinnMilk Oy, the
parent (Finland based) company’s capital structure would be different from its subsidiaries’
(china-based) capital structure. Depending on either parent or subsidiary is financing the
international project, country risks (economic and political factors), exchange rate risks etc.
affect the overall cost of capital. Therefore, it has to be borne in mind that MNCs like
FinnMilk Oy targets to obtain cheap funds to minimize their cost of capital under
consideration of those factors that may unfavorably affect the cost of capital.
As FinnMilk Oy is privately held unlevered company at its initial stage, founders’ invested
capital is the only form of equity. The company assumes that in order to expand its business
in the local markets, it needs more investment funds which exceed the owners’ capital. Apart
from private equity and venture financing, the company relies on debt for financing most of
its projects. However, the company restructures its capital by employing more equity
financing because of wider market capitalization and single currency in the euro-zone. Over
the lapse of time, FinnMilk Oy (parent company) is maintaining 70% equity and 30% debt in
its capital structure. So the company’s capital structure is slightly different from the capital
structure during its establishment. The firm has debt-equity ratio, 0.43, meaning that it has
low financial risks. This facilitates the company to get funds at low required rate of return
and investors are not concerned about their investments. Thus, FinnMilk Oy has been
capitalizing equity finance more in its capital structure and also other foreign projects. In
addition, FinnMilk Oy borrows money from local banks and issues corporate bonds
denominated in euro, which accounts 30% of the company’s long-term debt capital.
FinnMilk Oy now would like to build a new capital structure for its proposed subsidiary
based on the riskiness of the project, that is, 60% equity which comes from the accumulated
retained earnings over the time by the parent (FinnMilk Oy) and 40% debt which would be
financed by the China-based subsidiary. There are two options that the subsidiary can do
either by
i. borrowing money from the local Chinese banks, that is,
corporate loans; or

49
ii. issuing corporate bonds denominated in RNB on a long-
term basis in the Chinese Bond market.
The company also considers these two options for debt capital because the proposed
subsidiary either borrows from local banks or issues corporate bonds are not exposed to
exchange rate exposure while currency conversion.
The parent company estimates that the initial investment for the proposed subsidiary is say,
100 million including working capital. The company also estimates that 40% of that amount
is required for the subsidiary’s working capital needs. However, 60% of that amount would
be financed by the parent’s accumulated retained earnings (equity) required to establish the
subsidiary. The working capital needs of the subsidiary would be financed by themselves,
meaning that 40% of the initial investment would be borrowed from local banks or issued
corporate bonds in the market by the subsidiary. Thus, the subsidiary’s capital structure
consists of 60% equity by the parent and 40% debt by the subsidiary. Note that at least
FinnMilk Oy is not likely to use its own cost of capital to evaluate the proposed project.
The critical interpretation for using project’s capital structure of 60% equity and 40% debt by
the parent and the subsidiary respectively lies on many important factors. FinnMilk Oy would
invest 60% of its retained earnings to the proposed subsidiary because the company is going
to run international projects for the first time. The company assumes that external financing
might require a higher rate of return than the firm’s average required return for international
projects. However, these retained earnings are exposed to exchange rate risks when
converting euro against Yuan. Thus, what the company can do is to buy derivative products
such as currency call options.
Furthermore, the proposed subsidiary would borrow from local banks in order to satisfy the
working capital needed to run the business operations. The borrowed money from banks is
Chinese Yuan and thus, not exposed to exchange rate risks. Borrowing locally serves local
tax advantage because interest expense is tax deductible. Besides, the involvement with local
banks brings tangible and intangible benefits for the parent. It prevents hostile takeover
because there is historical trends of taking over foreign companies by local competitors in
China. However, the parent company thinks that local borrowing by the subsidiary also
depends on the cost of borrowed funds relative to the home country’s borrowed funds that are

50
also exposed to exchange rate risks when sending to the subsidiary. Therefore, the parent
company together with subsidiary would decide periodically about borrowings according to
the costs and benefits analysis.
2. It has assumed that FinnMilk Oy is privately owned equity company when it is first
created. In this case, only founders’ invested capital is the owner’s equity in the company. In
order to improve and grow its business operations in different local markets, the company
needs more investments which require capital. Because of its inadequate equity capital,
FinnMilk Oy relies on debt financing for mostly of its projects. The company takes short-
term and long-term corporate loans from local banks in Finland to smoothly operate its
business. Furthermore, the company raises fund by issuing corporate bonds denominated in
Euro since a private firm can issue corporate bonds based on its credit ratings, default risks,
maturities and yield. Over the time, the company’s use of debt is significant and properly
capitalized in a way to give back fixed return and produce more profits. The proportion of
debt capital (corporate loans/bonds) in the company would be higher than the equity capital.
In addition, FinnMilk Oy is not getting access to capital markets initially to extract funds by
issuing shares during creation of the company. The company relies on founders’ invested
capital which might not have enough for continuing the business operations. Consequently,
the company would have to depend on money market instruments as institutional investor.
Thus, the increased need for loans typically leads to the limited proportion of equity
financing in the company.
The following chart summaries the expected capital structure and financing decisions of both
FinnMilk Oy and the subsidiary.

51
Figure 12: Expected Capital Structure and Financing Decisions

52
Section 17: Long-Term Debt-Denomination Decision
The Ministry of Finance affirms the base rate in each June and December with effect for the
next half calendar year. The base rate is the average of 12-month Euribor rates published
during three calendar months prior to the affirmation of the base rate, rounded to the nearest
one-quarter percentage point. The Bank of Finland announces the reference rate used for the
determination of the penalty rate. The penalty rate is the reference rate plus 7 percentage
points in accordance with the Interest Rates Act. (Finlands Bank Eurosystemet 2016).
Table 7: Interest rate in Finland = Euribor rates + Bank’s rate + 7%
Nordea Prime rate
Change effective Interest rate
01.04.2016 0,008
01.01.2016 0,0095
01.06.2015 0,0105
01.04.2015 0,0115
10.11.2014 0,0125
12 months Euribor interest rates
03.10.2016 -0,064%
01.07.2016 -0,052%
01.04.2016 -0,002%
04.01.2016 0,058%
01.10.2015 0,140%
01.07.2015 0,164%
01.04.2015 0,196%
02.01.2015 0,323%
(Euribor interest rates 2016)
Nordea Prime Rate is intended mostly as a reference rate for private customers' long-term
loans (for example housing loans) and as a reference rate for long-term deposits. (Nordea
Bank Official Site 2016)

53
Figure 13: A graph describing the development of the Nordea Prime Rate and the Euribor
rates (Nordea Bank Official Site 2016)
Table 8: Interest rate in China. (3-5 years)
03.10.2016 4.75%
01.07.2016 4.75%
01.04.2016 4.75
04.01.2016 4.75
01.10.2015 4.75
01.07.2015 5.25%
01.04.2015 5.25%
02.01.2015 6%
As we can see, Euro interest rate is higher than Chinese interest rate over the lastͺquarters.
Moreover, Chinese interest rate has not been changed since October 2015. And here is
exactly the same tendency for short-term Chinese interest rate (1 year).

54
Graph Chinese interest rate PBC (1 year)
China's current borrowing rate is 4.75%. Euro interest rate is typically higher (present rate –
6.944%). According the facts that exchange rate EUR/CNY is mosty decreasing last 2 years
(-0.03 average change for last 2 years) and interest rate is stable last year (moreover it has
tendency to depreciate), it is better for FinnMilk Oy to borrow long-term funds denominated
in the Chinese currency of concern even if the company would have to pay slightly higher
interest rate than the rate shown.

55
Section 18: Ensuring Payment for Exports
The best option for FinnMilk Oy is to make long-term agreement with a dealer on Chinese
market that would be supply our product to Chinese stores. The price on our product
according this agreement must be in EURO to reduce all possible disadvantages of future
exchange rate for us.
Other variant is the agreement with using currency clause. Currency clause is a clause in a
contract that avoids problems of payment caused by exchange rate changes by fixing in
advance the exchange rate for the various transactions covered by the contract (QFinance,
Finance and Business Dictionary). That means that we can set in the contract that debt’s
currency would be a dollar, but currency of payment would be in yuan with the same amount
of money that is need to cover dollar-price of our products.
For timely remittance of funds from abroad better to use 100% payment in advance. Also
possible option – using contracts with a short-term payment delay (<15 days).

56
Section 19: Financing in Foreign Currency
1. 1.7.2015 to 30.9.2016
5.1%, 4.6%, 4.35%, 4.35% and 4.35%. (Quandl 2016).
While the Euro area interest is for the same period 4.75% in the first three quarters, then
dropped to 0% in the last two quarters. (refer to section 8)
The foreign interest rate of CNY is higher than that of Euro, and much stable.
We can first borrow CNY and convert them to Euro to get the funds needed. Then, we can
use the receivables in CNY to pay off the loan. In this way, financing in CNY reduces our
firm’s exposure to fluctuating exchange rates.
2. The company can issue bonds denominated in CNY, then we get CNY as our funds, and
there will be a natural offsetting effect that will reduce our company’s exposure to exchange
rate risk because we can use cash inflows in CNY to pay the debt.

57
Section 20: Concluding and Overall Assessment
FinnMilk Oy would first produce powdered infant milk in good quality and would also try to
set up subsidiary and export its brand to China. To begin with, FinnMilk Oy will concentrate
on the quality of products; then, in this way, the brand will be more and more popular among
the same products in an almost same price; at that time, the company can try to attract some
investors to invest in the company to export to China by analyzing the active market situation
and high demand of Chinese people for foreign brands.
Here are the positive aspects for our company:
1. CNY decreased compared to Euro in the period of time which we investigated, this
can indicate the basic trend of the exchange rate of Euro to CNY will mostly likely to
be stable or slightly increase in the future, which will benefit our company a lot in
increasing the opportunity of gaining more money through selling our products.
2. The powdered infant milk market in China will be suitable for the company’s
products. From the poisonous powdered infant milk issue in China, Chinese people
put more weight on the quality of the product instead of the price of it, and they are
also more willing to purchase some foreign bands. Milk in the Finland has a quite
good quality first, and the company will also guarantee the quality of our products to
be competitive.
3. The relationship between China and Finland is more and more friendly, which will
generate suitable international environment of the trades. And it will be much easier
for us to realize the export.
4. The market for powdered infant milk in China is very potential and large enough. The
peace environment in China and the boom situation in Chinese market give FinnMilk
Oy huge opportunity to develop here.
5. FinnMilk Oy can use such tools as currency options and futures and financing to
develop the company initially.
At the same time, there will also be some negative aspects.

58
1. The fluctuation of the exchange rate can also bring the possibility of reducing the
amount of our products export.
2. The stricter government control by China will give us more challenges when getting
into Chinese market.
3. Considering that FinnMilk Oy comes into being for a short period of time, the
reputation and the brand of the company won’t be so satisfying, which may bring us
great challenge when doing some financial activities.
4. The market in China is really big; as a result, it provides us with many competitors,
which will require the company to have much more advantages over them.

59
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Appendices
Appendix A
Infant Milk Powder: Online Survey
FinnMilk Oy has conducted an online survey to test the demand of Finnimi, its primary brand.
Due to time limitation of this study, the company has not come across all types of People in the
survey. The online survey was spread out online media such social networks as facebook,
Google+, LinkedIn, and blogs. The company has received 17 responses from diverse groups of
respondents. The online survey is attached in the following pages.

10/21/2016 Market Survey for Infant Milk powder
https://docs.google.com/forms/d/1LCc9yWRBNcNyWwGouPvgmMTCIcTfLuEOa3QkeTv1bc0/edit?c=0&w=1 1/3
Market Survey for Infant Milk powder
FinnMilk Oy, a finnish company, producing and marketing milk powder especially for babies. The baby
milk powder is named Finnimilk which is produced with pure and 100% natural ingredients to give a
comfortable digestion and taste. FinnMilk Oy wants to export finnimilk to China due to implied demand
for baby milk powder. For this, the company would like your cooperation to answer the following
question.
Questions
1. Do you ever buy milk powder for your baby(s)?你给你的孩子买过奶粉吗？
Check all that apply.
YES是
NO否
2. Do you feel free to buy and use foreign products ?你觉得购买和使用外国产品自由吗？
YES是
NO否
3. What does your buying decision lead to buy milk powder for your baby(s)?什么因素决定给你
的孩子买奶粉？
Price价格
Quality质
4. Will you pay for quality?你会为了质购买吗？
YES是
NO否
5. Do you have any children?你有孩子吗？
YES是
NO否
6. Do you think that current baby milk powders in the market are enough to satisfy your needs?
你觉得现在市场上的奶粉能满足你的需求吗？
YES是
NO否

10/21/2016 Market Survey for Infant Milk powder
https://docs.google.com/forms/d/1LCc9yWRBNcNyWwGouPvgmMTCIcTfLuEOa3QkeTv1bc0/edit?c=0&w=1 2/3
Powered by
7. If no, what things (additional value) do you think that you need ?如果不是，你还想要什么附加
的价值？

8. From where do you prefer to buy this product?你喜欢从哪买奶粉？
Mark only one oval.
Retail shops零售商店
Home delivery送上门
Online purchase在线购买
Others:其他
Skip to question 9.
Personal Information
9. How old are you?你的年龄
Below 20低于20
2035
3660
Above 60高于60
10. What is your sex?你的性别？
Male男
Female女
Other:
11. What is your educational qualification and
profession?你的教育背景？
12. Which country are you come?你来自哪个国
家？

When asked respondents, all of the respondents in the survey have given ‘YES’ and ‘NO’
answers of the following questions according to the survey questionnaire:
Table: YES & NO
Question’s order Number of
Respondents
YES (%) NO (%)
1 17 35 65
2 17 100 0
4 17 100 0
5 17 12 88
6 17 67 33
In response to question 3, 94% of the respondents have answered that they prefer to give
importance on quality rather price while 6% respondents replied that they prioritized on price.
In response to question 7, majority of the respondents (60%) have replied that they want more
nutritious and quality baby milk powder while the other 40% has emphasized on proper
ingredients and formula.
In response to question 8, all of the respondents (100%) have answered that they prefer to buy
from retail shops or stores.
The survey has also included personal information of respondents to in order to identify the
respondents’ class. FinnMilk Oy has obtained general information of customers’ attitude toward
its product.

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