Solution Manual For International
Financial Management 14th Edition by
Jeff Madura
, Solution Manual For International Financial Management 14th Edition by Jeff Madura
Chapter 1
Multinational Financial Management: An Overview
Lecture Outline
Managing the MNC
How Business Disciplines Are Used to Manage the MNC
Agency 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 Flows
How Uncertainty Affects the MNC’s Cost of Capital
Organization of the Text
, Multinational Financial Management: An Overview 2
Chapter Theme
This chapter introduces the multinational corporation as having similar goals to the purely domestic
corporation, but a wider variety of opportunities. With additional opportunities come potential increased
returns and other forms of risk to consider. The potential benefits and risks 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 business
norms 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 make the decision. Yet, in the United
States, a firm will sometimes take a client on an expensive golf outing or provide skybox tickets to
events. This is no different than a payoff. If the payoffs are bigger in some foreign countries, the MNC
can 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 to
any country, even if it is at a disadvantage in a foreign country that allows activities that might be viewed
as 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 a
standard code of ethics, but in reality, that means that it will not be able to compete in some cases. For
example, even if it submits the lowest bid on a specific foreign government project, it will not receive the
bid without a payoff to the foreign government officials. The issue is especially a concern for large
projects that may generate substantial cash flows for the firm that is chosen to do the project. Ideally, the
MNC can clearly demonstrate to whoever oversees the decision process that it deserves to be selected. If
there is just one decision-maker with no oversight, an MNC can not ensure that the decision will be
ethical. But if the decision-maker must be accountable to a department who oversees the decision, the
MNC may be able to prompt the department to ensure that the process is ethical.
, Multinational Financial Management: An Overview 3
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-making managers
and the owners of the MNC. Agency costs occur in an effort to assure that managers act in the best
interest 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 the
following reasons. First, MNCs incur larger agency costs in monitoring managers of distant foreign
subsidiaries. Second, foreign subsidiary managers raised in different cultures may not follow
uniform goals, and some managers may focus on satisfying respective employees. Third, the sheer
size 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 in
production, thereby relying on other countries for some products. Consequently, there is a need for
international 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 to
capitalize on its perceived advantages in markets 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 the
MNC. 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 markets? Why?
ANSWER: If perfect markets existed, resources would be more mobile and could therefore be
transferred to those countries more willing to pay a high price for them. As this occurred, shortages
of resources in any particular country would be alleviated and the costs of such resources would be
similar across countries.
4. International Opportunities.
, Multinational Financial Management: An Overview 4
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 normally
requires 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 lack knowledge about foreign markets
or 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 at
various 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 risk perception
of international business will influence the degree to which a firm becomes internationalized. Several
other factors such as access to capital could also be relevant here. Firms that are labor-intensive could
more 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 that
firms could now develop contacts with potential customers overseas by having a website. Many firms
use their website to identify the products that they sell, along with the prices for each product. This
allows them to easily advertise their products to potential importers anywhere in the world without
mailing brochures to various countries. In addition, they can add to their product line and change
prices by simply revising their website, so importers are kept abreast of the exporter’s product
information by monitoring the exporter’s website periodically. Firms can also use their websites to
accept orders online. Some firms with an international reputation use their brand name to advertise
products over the internet. They may use manufacturers in some foreign countries to produce some
of their products subject to their specification
6. Impact of Exchange Rate Movements. Plak Co. of Chicago has several European subsidiaries that
remit earnings to it each year. Explain how appreciation of the euro (the currency used in many
European countries) would affect Plak's valuation.
ANSWER: Plak’s valuation should increase because the appreciation of the euro will increase the
dollar value of the cash flows remitted by the European subsidiaries.
, Multinational Financial Management: An Overview 5
7. Benefits and Risks of International Business. As an overall review of this chapter, identify
possible reasons for growth in international business. Then, list the various disadvantages that may
discourage international business.
ANSWER: Growth in international business can be stimulated by (1) access to foreign resources
which can reduce costs, or (2) access to foreign markets which boost revenues. Yet, international
business is subject to risks of exchange rate fluctuations, and political risk (such as a possible host
government takeover, tax regulations, etc.).
8. Valuation of an MNC. Hudson Co., a U.S. firm, has a subsidiary in Mexico, where political risk has
recently increased. Hudson's best guess of its future peso cash flows to be received has not changed.
However, its valuation has declined as a result of the increase in political risk. Explain.
ANSWER: The valuation of the MNC is the present value of expected cash flows. The increase in
risk results in a higher expected return, which reduces the present value of the expected future cash
flows.
9. Centralization and Agency Costs. Would the agency problem be more pronounced for Berkley
Corp., whose parent company makes most major decisions for its foreign subsidiaries, or Oakland
Corp., which uses a decentralized approach?
ANSWER: The agency problem would be more pronounced for Oakland because of a higher
probability that subsidiary decisions would conflict with the parent. Assuming that the parent
attempts to maximize shareholder wealth, decisions by the parent should be compatible with
shareholder objectives. If the subsidiaries made their own decisions, the agency costs would be
higher since the parent would need to monitor the subsidiaries to assure that their decisions were
intended to maximize shareholder wealth.
10. Global Competition. Explain why more standardized product specifications across countries can
increase global competition.
ANSWER: Standardized product specifications allow firms to more easily expand their business
across other countries, which increases global competition.
11. Exposure to Exchange Rates. McCanna Corp., a U.S. firm, has a French subsidiary that produces
wine. All of the European countries where it sells its wine use the euro as their currency, which is
the same as the currency used in France. Is McCanna Corp. exposed to exchange rate risk?
ANSWER: The subsidiary and its customers based in countries that now use the euro as their
currency would no longer be exposed to exchange rate risk. However, McCanna Corp is exposed to
exchange rate risk, because the subsidiary will ultimately remit its earnings to the parent, and the
euro earnings will be converted to dollars when they are remitted.
12. Macro versus Micro Topics. Review this book’s table of contents and indicate whether each of the
chapters from Chapter 2 through Chapter 21 has a macro or micro perspective.
ANSWER: Chapters 2 through 8 are macro, while Chapters 9 through 21 are micro.
, Multinational Financial Management: An Overview 6
13. Methods Used to Conduct International Business. Duve, Inc., desires to penetrate a foreign market
either by crafting a licensing agreement with a foreign firm or by acquiring a foreign firm. Explain
the differences in potential risk and return between licensing with a foreign firm and acquiring a
foreign firm.
ANSWER: A licensing agreement has limited potential for return, because the foreign firm will
receive much of the benefits as a result of the licensing agreement. Yet, the MNC has limited risk,
because it did not need to invest substantial funds in the foreign country.
An acquisition by the MNC requires a substantial investment. If this investment is not a success, the
MNC may have trouble selling the firm it acquired for a reasonable price. Thus, there is more risk.
However, if this investment is successful, all of the benefits accrue to the MNC.
14. International Business Methods. Snyder Golf Co., a U.S. firm that sells high-quality golf clubs in
the U.S., wants to expand internationally by selling the same golf clubs in Brazil.
a. Describe the tradeoffs that are involved for each method (such as exporting, direct foreign
investment, and so on) that Snyder could use to achieve its goal.
ANSWER: Snyder can export the clubs, but the transportation expenses may be high. If could
establish a subsidiary in Brazil to produce and sell the clubs, but this may require a large investment
of funds. It could use licensing, in which it specifies to a Brazilian firm how to produce the clubs. In
this way, it does not have to establish its own subsidiary there.
b. Which method of international method would you recommend for this firm? Justify your
recommendation.
ANSWER: If the amount of golf clubs to be sold in Brazil is small, it may decide to export.
However, if the expected sales level is high, it may benefit from licensing. If it is confident that the
expected sales level will remain high, it may be willing to establish a subsidiary. The wages are
lower in Brazil, and the large investment needed to establish a subsidiary may be worthwhile.
15. Impact of Political Risk. Explain why political risk may discourage international business.
ANSWER: Political risk increases the rate of return required to invest in foreign projects. Some
foreign projects would have been feasible if there was no political risk but will not be feasible
because of political risk.
16. Impact of 9/11. Following the terrorist attack on the U.S., the valuations of many MNCs declined by
more than 10 percent. Explain why the expected cash flows of MNCs were reduced, even if they
were not directly hit by the attacks.
ANSWER: An MNC’s cash flows could be reduced in the following ways. First, a decline in travel
would affect any MNCs that have business in travel-related industries. The airline, hotel, and tourist-
related industries were expected to experience a decline in business. Layoffs were announced
immediately by many of these MNCs. Second, these effects on travel-related industries can carry
over to other industries and weaken economies. Third, the cost of international trade increased as a
result of tighter restrictions on some products. Fourth, some MNCs incurred expenses as a result of
increasing security to protect their employees.
, Multinational Financial Management: An Overview 7
Advanced Questions
17. International Joint Venture. Anheuser-Busch, (which is now part of AB InBev due to a merger),
the producer of Budweiser and other beers, has engaged in a joint venture with Kirin Brewery, the
largest brewery in Japan. The joint venture enables Anheuser-Busch to have its beer distributed
through Kirin’s distribution channels in Japan. In addition, it could utilize Kirin’s facilities to
produce beer that would be sold locally. In return, Anheuser-Busch provided information about the
American beer market to Kirin.
a. Explain how the joint venture enabled Anheuser-Busch to achieve its objective of maximizing
shareholder wealth.
ANSWER: The joint venture creates a way for Anheuser-Busch to distribute Budweiser throughout
Japan. It enables Anheuser-Busch to penetrate the Japanese market without requiring a substantial
investment in Japan.
b. Explain how the joint venture limited the risk of the international business.
ANSWER: The joint venture has limited risk because Anheuser-Busch does not need to establish its
own distribution network in Japan. Thus, Anheuser-Busch may be able to use a smaller investment
for the international business, and there is a higher probability that the international business will be
successful.
c. Many international joint ventures are intended to circumvent barriers that might otherwise
prevent foreign competition. What barrier in Japan did Anheuser-Busch circumvent as a result
of the joint venture? What barrier in the United States did Kirin circumvent as a result of the
joint venture?
ANSWER: Anheuser-Busch is able to benefit from Kirin’s distribution system in Japan, which would
not normally be so accessible. Kirin is able to learn more about how Anheuser-Busch expanded its
product across numerous countries, and therefore breaks through an “information” barrier.
d. Explain how Anheuser-Busch could have lost some of its market share in countries outside Japan
as a result of this particular joint venture.
ANSWER: Anheuser-Busch could lose some of its market share to Kirin as a result of explaining its
worldwide expansion strategies to Kirin. However, it appears that Anheuser-Busch expects the
potential benefits of the joint venture to outweigh any potential adverse effects.
18. Impact of Eastern European Growth. The managers of Loyola Corp. recently had a meeting to
discuss new opportunities in Europe as a result of the recent integration among Eastern European
countries. They decided not to penetrate new markets because of their present focus on expanding
market share in the United States. Loyola’s financial managers have developed forecasts for
earnings based on the 12 percent market share (defined here as its percentage of total European sales)
that Loyola currently has in Eastern Europe. Is 12 percent an appropriate estimate for next year’s
Eastern European market share? If not, does it likely overestimate or underestimate next year’s
actual Eastern European market share next year?
, Multinational Financial Management: An Overview 8
ANSWER: It would likely overestimate its market share because the competition should increase as
competitors penetrate the European countries.
19. Valuation of an MNC. Birm Co., based in Alabama, is considering several international
opportunities in Europe that could affect the firm’s value. The valuation depends on four factors: (1)
expected cash flows in dollars, (2) expected cash flows in euros that are ultimately converted into
dollars, (3) the rate at which it can convert euros to dollars, and (4) Birm’s weighted average cost of
capital. For each of the following opportunities, identify the factors that will be affected.
a. Birm plans a licensing deal in which it will sell technology to a firm in Germany for $3,000,000;
the payment is invoiced in dollars, and this project has the same risk level as its existing
businesses.
b. Birm plans to acquire a large firm in Portugal that is riskier than its existing businesses.
c. Birm plans to discontinue its relationship with a U.S. supplier so that can import a small amount
of supplies (denominated in euros) at a lower cost from a Belgian supplier.
d. Birm plans to export a small amount of materials to Ireland that are denominated in euros.
ANSWER:
Exchange rate at Birm’s weighted
which Birm Co. average cost of
Opportunity Dollar CF Euro CF
converts euros to capital
dollars
a. joint venture X
b. acquisition X X
c. imported supplies X
d. exports to Ireland X
20. Assessing Motives for International Business. Fort Worth Inc. specializes in manufacturing some
basic parts for sports utility vehicles that are produced and sold in the U.S. Its main advantage in the
U.S. is that its production is efficient, and less costly than that of some other unionized
manufacturers. It has a substantial market share in the U.S. Its manufacturing process is labor-
intensive. The company pays relatively low wages compared to its U.S. competitors, but it has
guaranteed the local workers that their positions will not be eliminated for the next 30 years. It hired
a consultant to determine whether it should set up a subsidiary in Mexico, where the parts would be
produced. The consultant suggested that Forth Worth expand for the following reasons. Offer your
opinion on whether the consultant’s reasons are logical:
a. Theory of Competitive Advantage: Not many SUVs are sold in Mexico; hence, Fort Worth Inc.
would not face much competition there.
b. Imperfect Markets Theory: Fort Worth can not easily transfer workers to Mexico, but it can
establish a subsidiary there that it can use to penetrate a new market.
