The document discusses financial management in international business. It covers three key areas: investment decisions about what activities to finance, financing decisions about how to fund activities, and money management decisions to efficiently manage financial resources. For investment decisions, it notes the complex capital budgeting process for foreign investments. For financing decisions, it discusses options for sourcing financing and financial structure considerations. For money management, it outlines techniques for efficiently managing cash flows globally like netting transactions between subsidiaries.

2. Chapter Twenty
Financial Management in the
International Business

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Scope of Financial Management
• Scope of financial management includes three sets of
related decisions:
• Investment decisions
- Decisions about what activities to finance
• Financing decisions
- Decisions about how to finance those activities
• Money management decisions
- Decisions about how to manage the firm’s financial
resources most efficiently

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Investment Decisions
• Capital budgeting:
- Quantifies the benefits, costs and risks of an
investment
- Managers can reasonably compare different
investment alternatives within and across countries
• Complicated process:
- Must distinguish between cash flows to project and those
to parent
- Political and economic risk can change the value of a
foreign investment
- Connection between cash flows to parent and the source of
financing must be recognized

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Project and Parent Cash Flows
• Project cash flows may not reach the parent:
- Host country may block cash-flow repatriation
- Cash flows may be taxed at an unfavorable rate
- Host government may require a percentage of cash flows
to be reinvested in the host country

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Adjusting for Political and
Economic Risk
• Political risk:
- Expropriation - Iranian revolution, 1979
- Social unrest - after the breakup of Yugoslavia, company
assets were rendered worthless
- Political change - may lead to tax and ownership changes
• Collapse of communism in Eastern Europe
• Attack on the World Trade Center
• Economic risk
- Inflation

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Financing Decisions
• When considering options for financing a foreign
investment, international businesses have to consider
two factors
- Source of financing
- Financial structure

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Financing Decisions and
The Global Capital Market
• A capital market brings together those who want to invest
money and those who want to borrow money
• Those who want to invest money include
- Corporations
- Individuals
- Non-bank financial institutions
• Those who want to borrow money include
- Individuals
- Companies
- Governments

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Financing Decisions and
The Global Capital Market
• Capital market loans to corporations re either
- Equity loans occur when corporations sell stock to investors
- Debt loans occur when a corporation borrows money and agrees
to repay a predetermined portion of the loan amount at regular
intervals regardless of how much profit it is making
• Cost of capital is the price of borrowing money, which is the
rate of return that borrowers must pay investors
- In a purely domestic capital market the pool of investors is limited
to residents of the country
• Places an upper limit on the supply of funds available
• Increases the cost of capital
- A global capital market provides a larger supply of funds for
borrowers to draw on
• Lowers the cost of capital

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Financing Decisions and
The Global Capital Market

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Source of Financing
• Global capital markets for lower cost financing.
• Impact of host country - may require projects to be
locally financed through debt or equity
- Limited liquidity raises the cost of capital
- Host government may offer low interest or subsidized loans
to attract investment
• Impact of local currency (appreciation/depreciation)
influences capital and financing decisions

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Financial Structure
• Financial structure:
- Debt/equity ratios vary with countries
• Tax regimes
- Follow local capital structure norms?
• More easily evaluate return on equity relative to local
competition
• Good for company’s image
• Best recommendation: adopt a financial structure that
minimizes the cost of capital

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Global Money Management
-The Efficiency Objective
• Minimizing cash balances:
- Money market accounts - low interest - high liquidity
- Certificates of deposit - higher interest - lower liquidity
• Reducing transaction costs (cost of exchange):
- Transaction costs: changing from one currency to
another
- Transfer fee: fee for moving cash from one location to
another

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Global Money Management
The Tax Objective
• Countries tax income earned outside their boundaries
by entities based in their country
- Can lead to double taxation
- Tax credit allows entity to reduce home taxes by amount
paid to foreign government
- Tax treaty is an agreement between countries specifying
what items will be taxed by authorities in country where
income is earned
- Deferral principle specifies that parent companies will not
be taxed on foreign income until the dividend is received
- Tax haven is used to minimize tax liability

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2004 Corporate Tax Rates

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Moving Money Across Borders:
Attaining Efficiencies and Reducing Taxes
• Unbundling: A mix of techniques to transfer liquid
funds from a foreign subsidiary to the parent company
without piquing the host country
- Dividend remittances
- Royalty payments and fees
- Transfer Prices
- Fronting loans
• Selecting a particular policy is limited when a foreign
subsidiary is part owned by a local joint-venture
partner or local stockholders

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Dividend Remittances
• Most common method of transfer
• Dividend varies with:
- Tax regulations
- Foreign exchange risk
- Age of subsidiary
- Extent of local equity participation

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Royalty Payments and Fees
• Royalties represent the remuneration paid to owners of
technology, patents or trade names for their use by the
firm
- Common for parent to charge a subsidiary for
technology, patents or trade names transferred to it
- May be levied as a fixed amount per unit sold or
percentage of revenue earned
• Fees are compensation for professional services or
expertise supplied to subsidiary
- Management fees or ‘technical assistance’ fees
- Fixed charges for services provided

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Transfer Prices
• Price at which goods or services are transferred within
a firm’s entities
- Position funds within a company
• Move founds out of country by setting high transfer fees or
into a country by setting low transfer fees
- Movement can be within subsidiaries or between the
parent and its subsidiaries

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Benefits of Manipulating
Transfer Prices
• Reduce tax liabilities by using transfer fees to shift
from a high-tax country to a low-tax country
• Reduce foreign exchange risk exposure to expected
currency devaluation by transferring funds
• Can be used where dividends are restricted or blocked
by host-government policy
• Reduce import duties (ad valorem) by reducing
transfer prices and the value of the goods

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Problems With
Transfer Pricing
• Few governments like it
- Believe (rightly) that they are losing revenue
• Has an impact on management incentives and
performance evaluations
- Inconsistent with a ‘profit center’
- Managers can hide inefficiencies

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Fronting Loans
• Loan between a parent and subsidiary is channeled
through a financial intermediary (bank)
- Allows circumvention of host country restrictions on
remittance of funds from subsidiary to parent
- Provides certain tax advantages

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Tax Advantages of
Fronting Loans

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Techniques for Global
Money Management
• Need cash reserves to service accounts and insuring
against negative cash flows
• Should each subsidiary hold its own cash balance?
- By pooling, firm can deposit larger cash amounts and
earn higher interest rates
- If located in a major financial center, can get
information on good investment opportunities
- Can reduce the total size of cash pool and invest
larger reserves in higher paying, long term,
instruments

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Centralized Depositories

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Techniques for
Global Money Management
• Ability to reduce
transaction costs
- Bilateral netting
- Multilateral netting –
simply extending the
bilateral concept to
multiple subsidiaries
within an international
business

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Cash Flows Before
Multilateral Netting

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Cash Flows After
Multilateral Netting