Chapter 1
Multinational Financial Management: An Overview
Lecture Outline
Managing the MNC
How Business Disciplines Are Used to Manage the
MNCAgency Problems
Management Structure of an MNC
Why Firms Pursue International Business
Theory of Comparative Advantage
Imperfect Mar𝑘ets Theory
Product Cycle Theory
Methods to Conduct International Business
International Trade
Licensing
Franchising
Joint Ventures
Acquisitions of Existing Operations
Establishing New Foreign Subsidiaries
Summary of Methods
Valuation Model for an MNC
Domestic Valuation Model
Multinational Valuation Model
Uncertainty Surrounding an MNC’s Cash FlowsHow
Uncertainty Affects the MNC’s Cost of Capital
Organization of the Text
© Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use aspermitted
in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
, Multinational Financial Management: An Overview2
Chapter Theme
This chapter introduces the multinational corporation as having similar goals to the purely
domesticcorporation, but a wider variety of opportunities. With additional opportunities come potential
increasedreturns and other forms of ris𝑘 to consider. The potential benefits and ris 𝑘s are introduced.
Topics to Stimulate Class Discussion
1. What is the appropriate definition of an MNC?
2. Why does an MNC expand internationally?
3. What are the ris𝑘s of an MNC which expands internationally?
4. Why must purely domestic firms be concerned about the international environment?
POINT/COUNTER-POINT:
Should an MNC Reduce Its Ethical Standards to Compete Internationally?
POINT: Yes. When a U.S.-based MNC competes in some countries, it may encounter some
businessnorms there that are not allowed in the U.S. For example, when competing for a government
contract,firms might provide payoffs to the government officials who will ma 𝑘e the decision. Yet, in
the UnitedStates, a firm will sometimes ta𝑘e a client on an expensive golf outing or provide s 𝑘ybox
tic𝑘ets toevents. This is no different than a payoff. If the payoffs are bigger in some foreign countries,
the MNCcan compete only by matching the payoffs provided by its competitors.
COUNTER-POINT: No. A U.S.-based MNC should maintain a standard code of ethics that applies toany
country, even if it is at a disadvantage in a foreign country that allows activities that might be viewedas
unethical. In this way, the MNC establishes more credibility worldwide.
WHO IS CORRECT? Use the Internet to learn more about this issue. Which argument do you support?
Offer your own opinion on this issue.
ANSWER: The issue is frequently discussed. It is easy to suggest that the MNC should maintain astandard
code of ethics, but in reality, that means that it will not be able to compete in some cases. Forexample,
even if it submits the lowest bid on a specific foreign government project, it will not receive thebid without
a payoff to the foreign government officials. The issue is especially a concern for largeprojects that may
generate substantial cash flows for the firm that is chosen to do the project. Ideally, theMNC can clearly
demonstrate to whoever oversees the decision process that it deserves to be selected. Ifthere is just one
decision-ma𝑘er with no oversight, an MNC can not ensure that the decision will beethical. But if the
decision-ma𝑘er must be accountable to a department who oversees the decision, theMNC may be able to
prompt the department to ensure that the process is ethical.
© Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use aspermitted
in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
, Multinational Financial Management: An Overview3
Answers to End of Chapter Questions
1.Agency Problems of MNCs.
a. Explain the agency problem of MNCs.
ANSWER: The agency problem reflects a conflict of interests between decision-ma 𝑘ing
managersand the owners of the MNC. Agency costs occur in an effort to assure that managers act in
the bestinterest of the owners.
b.Why might agency costs be larger for an MNC than for a purely domestic firm?
ANSWER: The agency costs are normally larger for MNCs than purely domestic firms for
thefollowing reasons. First, MNCs incur larger agency costs in monitoring managers of distant
foreignsubsidiaries. Second, foreign subsidiary managers raised in different cultures may not
followuniform goals, and some managers may focus on satisfying respective employees. Third, the
sheersize of the larger MNCs would also create large agency problems.
2.Comparative Advantage.
a. Explain how the theory of comparative advantage relates to the need for international business.
ANSWER: The theory of comparative advantage implies that countries should specialize
inproduction, thereby relying on other countries for some products. Consequently, there is a need
forinternational business.
b. Explain how the product cycle theory relates to the growth of an MNC.
ANSWER: The product cycle theory suggests that at some point in time, the firm will attempt
tocapitalize on its perceived advantages in mar 𝑘ets other than where it was initially established.
3.Imperfect Mar𝑘ets.
a. Explain how the existence of imperfect mar𝑘ets has led to the establishment of subsidiaries in
foreign mar𝑘ets.
ANSWER: Because of imperfect mar𝑘ets, resources cannot be easily and freely retrieved by
theMNC. Consequently, the MNC must sometimes go to the resources rather than retrieve
resources(such as land, labor, etc.).
b. If perfect mar𝑘ets existed, would wages, prices, and interest rates among countries be more
similar or less similar than under conditions of imperfect mar 𝑘ets? Why?
ANSWER: If perfect mar𝑘ets existed, resources would be more mobile and could therefore
betransferred to those countries more willing to pay a high price for them. As this occurred,
shortagesof resources in any particular country would be alleviated and the costs of such resources
would besimilar across countries.
4. International Opportunities.
© Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use aspermitted
in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
, Multinational Financial Management: An Overview4
a.Do you thin𝑘 that either the acquisition of a foreign firm or licensing will result in greater growth
for an MNC? Which alternative is li𝑘ely to have more ris𝑘?
ANSWER: An acquisition will typically result in greater growth, but it is ris𝑘ier because it
normallyrequires a larger investment and the decision can not be easily reversed once the acquisition is
made.
b. Describe a scenario in which the size of a corporation is not affected by access to international
opportunities.
ANSWER: Some firms may avoid opportunities because they lac 𝑘 𝑘nowledge about foreign
mar𝑘etsor expect that the ris𝑘s are excessive. Thus, the size of these firms is not affected by the
opportunities.
c. Explain why MNCs such as Coca Cola and PepsiCo still have numerous opportunities for
international expansion.
ANSWER: Coca Cola and PepsiCo still have new international opportunities because countries are
atvarious stages of development. Some countries have just recently opened their borders to MNCs.
Many of these countries do not offer sufficient food or drin𝑘 products to their consumers.
5. International Opportunities Due to the Internet.
a.What factors cause some firms to become more internationalized than others?
ANSWER: The operating characteristics of the firm (what it produces or sells) and the ris 𝑘
perceptionof international business will influence the degree to which a firm becomes
internationalized. Severalother factors such as access to capital could also be relevant here. Firms that
are labor-intensive couldmore easily capitalize on low-wage countries while firms that rely on
technological advances could not.
b.Why might the Internet have resulted in more international business.
ANSWER: The Internet allows for easy and low-cost communication between countries, so thatfirms
could now develop contacts with potential customers overseas by having a website. Many firmsuse
their website to identify the products that they sell, along with the prices for each product. Thisallows
them to easily advertise their products to potential importers anywhere in the world withoutmailing
brochures to various countries. In addition, they can add to their product line and changeprices by
simply revising their website, so importers are 𝑘ept abreast of the exporter ’s productinformation by
monitoring the exporter’s website periodically. Firms can also use their websites toaccept orders
online. Some firms with an international reputation use their brand name to advertiseproducts over the
internet. They may use manufacturers in some foreign countries to produce someof their products
subject to their specification
6. Impact of Exchange Rate Movements.Pla𝑘 Co. of Chicago has several European subsidiaries
thatremit earnings to it each year. Explain how appreciation of the euro (the currency used in
manyEuropean countries) would affect Pla𝑘's valuation.
ANSWER: Pla𝑘’s valuation should increase because the appreciation of the euro will increase
thedollar value of the cash flows remitted by the European subsidiaries.
Multinational Financial Management: An Overview
Lecture Outline
Managing the MNC
How Business Disciplines Are Used to Manage the
MNCAgency Problems
Management Structure of an MNC
Why Firms Pursue International Business
Theory of Comparative Advantage
Imperfect Mar𝑘ets Theory
Product Cycle Theory
Methods to Conduct International Business
International Trade
Licensing
Franchising
Joint Ventures
Acquisitions of Existing Operations
Establishing New Foreign Subsidiaries
Summary of Methods
Valuation Model for an MNC
Domestic Valuation Model
Multinational Valuation Model
Uncertainty Surrounding an MNC’s Cash FlowsHow
Uncertainty Affects the MNC’s Cost of Capital
Organization of the Text
© Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use aspermitted
in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
, Multinational Financial Management: An Overview2
Chapter Theme
This chapter introduces the multinational corporation as having similar goals to the purely
domesticcorporation, but a wider variety of opportunities. With additional opportunities come potential
increasedreturns and other forms of ris𝑘 to consider. The potential benefits and ris 𝑘s are introduced.
Topics to Stimulate Class Discussion
1. What is the appropriate definition of an MNC?
2. Why does an MNC expand internationally?
3. What are the ris𝑘s of an MNC which expands internationally?
4. Why must purely domestic firms be concerned about the international environment?
POINT/COUNTER-POINT:
Should an MNC Reduce Its Ethical Standards to Compete Internationally?
POINT: Yes. When a U.S.-based MNC competes in some countries, it may encounter some
businessnorms there that are not allowed in the U.S. For example, when competing for a government
contract,firms might provide payoffs to the government officials who will ma 𝑘e the decision. Yet, in
the UnitedStates, a firm will sometimes ta𝑘e a client on an expensive golf outing or provide s 𝑘ybox
tic𝑘ets toevents. This is no different than a payoff. If the payoffs are bigger in some foreign countries,
the MNCcan compete only by matching the payoffs provided by its competitors.
COUNTER-POINT: No. A U.S.-based MNC should maintain a standard code of ethics that applies toany
country, even if it is at a disadvantage in a foreign country that allows activities that might be viewedas
unethical. In this way, the MNC establishes more credibility worldwide.
WHO IS CORRECT? Use the Internet to learn more about this issue. Which argument do you support?
Offer your own opinion on this issue.
ANSWER: The issue is frequently discussed. It is easy to suggest that the MNC should maintain astandard
code of ethics, but in reality, that means that it will not be able to compete in some cases. Forexample,
even if it submits the lowest bid on a specific foreign government project, it will not receive thebid without
a payoff to the foreign government officials. The issue is especially a concern for largeprojects that may
generate substantial cash flows for the firm that is chosen to do the project. Ideally, theMNC can clearly
demonstrate to whoever oversees the decision process that it deserves to be selected. Ifthere is just one
decision-ma𝑘er with no oversight, an MNC can not ensure that the decision will beethical. But if the
decision-ma𝑘er must be accountable to a department who oversees the decision, theMNC may be able to
prompt the department to ensure that the process is ethical.
© Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use aspermitted
in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
, Multinational Financial Management: An Overview3
Answers to End of Chapter Questions
1.Agency Problems of MNCs.
a. Explain the agency problem of MNCs.
ANSWER: The agency problem reflects a conflict of interests between decision-ma 𝑘ing
managersand the owners of the MNC. Agency costs occur in an effort to assure that managers act in
the bestinterest of the owners.
b.Why might agency costs be larger for an MNC than for a purely domestic firm?
ANSWER: The agency costs are normally larger for MNCs than purely domestic firms for
thefollowing reasons. First, MNCs incur larger agency costs in monitoring managers of distant
foreignsubsidiaries. Second, foreign subsidiary managers raised in different cultures may not
followuniform goals, and some managers may focus on satisfying respective employees. Third, the
sheersize of the larger MNCs would also create large agency problems.
2.Comparative Advantage.
a. Explain how the theory of comparative advantage relates to the need for international business.
ANSWER: The theory of comparative advantage implies that countries should specialize
inproduction, thereby relying on other countries for some products. Consequently, there is a need
forinternational business.
b. Explain how the product cycle theory relates to the growth of an MNC.
ANSWER: The product cycle theory suggests that at some point in time, the firm will attempt
tocapitalize on its perceived advantages in mar 𝑘ets other than where it was initially established.
3.Imperfect Mar𝑘ets.
a. Explain how the existence of imperfect mar𝑘ets has led to the establishment of subsidiaries in
foreign mar𝑘ets.
ANSWER: Because of imperfect mar𝑘ets, resources cannot be easily and freely retrieved by
theMNC. Consequently, the MNC must sometimes go to the resources rather than retrieve
resources(such as land, labor, etc.).
b. If perfect mar𝑘ets existed, would wages, prices, and interest rates among countries be more
similar or less similar than under conditions of imperfect mar 𝑘ets? Why?
ANSWER: If perfect mar𝑘ets existed, resources would be more mobile and could therefore
betransferred to those countries more willing to pay a high price for them. As this occurred,
shortagesof resources in any particular country would be alleviated and the costs of such resources
would besimilar across countries.
4. International Opportunities.
© Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use aspermitted
in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
, Multinational Financial Management: An Overview4
a.Do you thin𝑘 that either the acquisition of a foreign firm or licensing will result in greater growth
for an MNC? Which alternative is li𝑘ely to have more ris𝑘?
ANSWER: An acquisition will typically result in greater growth, but it is ris𝑘ier because it
normallyrequires a larger investment and the decision can not be easily reversed once the acquisition is
made.
b. Describe a scenario in which the size of a corporation is not affected by access to international
opportunities.
ANSWER: Some firms may avoid opportunities because they lac 𝑘 𝑘nowledge about foreign
mar𝑘etsor expect that the ris𝑘s are excessive. Thus, the size of these firms is not affected by the
opportunities.
c. Explain why MNCs such as Coca Cola and PepsiCo still have numerous opportunities for
international expansion.
ANSWER: Coca Cola and PepsiCo still have new international opportunities because countries are
atvarious stages of development. Some countries have just recently opened their borders to MNCs.
Many of these countries do not offer sufficient food or drin𝑘 products to their consumers.
5. International Opportunities Due to the Internet.
a.What factors cause some firms to become more internationalized than others?
ANSWER: The operating characteristics of the firm (what it produces or sells) and the ris 𝑘
perceptionof international business will influence the degree to which a firm becomes
internationalized. Severalother factors such as access to capital could also be relevant here. Firms that
are labor-intensive couldmore easily capitalize on low-wage countries while firms that rely on
technological advances could not.
b.Why might the Internet have resulted in more international business.
ANSWER: The Internet allows for easy and low-cost communication between countries, so thatfirms
could now develop contacts with potential customers overseas by having a website. Many firmsuse
their website to identify the products that they sell, along with the prices for each product. Thisallows
them to easily advertise their products to potential importers anywhere in the world withoutmailing
brochures to various countries. In addition, they can add to their product line and changeprices by
simply revising their website, so importers are 𝑘ept abreast of the exporter ’s productinformation by
monitoring the exporter’s website periodically. Firms can also use their websites toaccept orders
online. Some firms with an international reputation use their brand name to advertiseproducts over the
internet. They may use manufacturers in some foreign countries to produce someof their products
subject to their specification
6. Impact of Exchange Rate Movements.Pla𝑘 Co. of Chicago has several European subsidiaries
thatremit earnings to it each year. Explain how appreciation of the euro (the currency used in
manyEuropean countries) would affect Pla𝑘's valuation.
ANSWER: Pla𝑘’s valuation should increase because the appreciation of the euro will increase
thedollar value of the cash flows remitted by the European subsidiaries.
