Homework 5

1.Why are valuations of privatized businesses previously owned by the governments of

developing countries more difficult than valuations of existing firms in developed

countries?

The international market for corporate control serves as another form of governance because

public firms that do not serve their shareholders may become subject to takeovers. However,

managers of public firms can implement some tactics such as anti-takeover provisions and

poison pills to protect against takeovers (Madura, 2013). The valuation of a firms target is

influenced by target-specific factors (as the targets previous cash flows and its managerial

talent) and country-specific factors (such as economic conditions, political conditions, currency

conditions, and stock market conditions) (Madura, 2013). The valuation of a proposed

international divestiture requires comparing the present value of the cash flows if the project is

continued to the proceeds that would be received (after taxes) if the project is divested. In the

typical valuation process, an MNC initially screens prospective targets based on willingness to

be acquired and country barriers (Madura, 2013). Each prospective target is valued by estimating

its cash flows, based on target specific characteristics and the targets country characteristics, and

by discounting the expected cash flows. Then, the perceived value is compared to the targets

market value to determine whether the target can be purchased at a price that is below the

perceived value from the MNCs perspective (Madura, 2013). Valuations of a foreign target may

vary among potential acquirers because of differences in estimates of the targets cash flows or

exchange rate movements or differences in the required rate of return among acquirers. These

differences may be especially pronounced when the potential acquirers are from different

countries (Madura, 2013). Besides international acquisitions of firms, international corporate

control transactions include international partial acquisitions, international acquisitions of

privatized businesses, and international divestitures. The feasibility of these types of transactions

can be assessed by applying multinational capital budgeting (Madura, 2013).

2.Bronco Corp. has decided to establish a subsidiary in Taiwan that will produce stereos

and sell them there. It expects that its cost of producing these stereos will be one-third the

cost of producing them in the United States. Assuming that its production cost estimates

are accurate, is Broncos strategy sensible? Explain.

MNCs may be motivated to initiate direct foreign investment in order to attract new sources of

demand or to enter markets where superior profits are possible. These two motives are normally

based on opportunities to generate more revenue in foreign markets (Madura, 2013). Other

motives for using DFI are typically related to cost efficiency, such as using foreign factors of

production, raw materials, or technology (Madura, 2013). In addition MNCs may engage in DFI

to protect their foreign market share, to react to exchange rate movements, or to avoid trade

restrictions. International diversification is a common motive for direct foreign investment. It

allows an MNC to reduce its exposure to domestic economic conditions (Madura, 2013). In this

way, the MNC may be able to stabilize its cash flows and reduce its risk. Such a goal is desirable

because it may reduce the firms cost of financing (Madura, 2013). International projects may

allow MNCs to achieve lower risk than is possible from only domestic projects without reducing

their expected returns. International diversification tends to be better able to reduce risk when the

DFI is targeted to countries whose economies are somewhat unrelated to an MNCs home

country economy (Madura, 2013). Some host governments boost DFI in its country by offering

incentives to MNCs, such as tax breaks. However, host governments sometimes impose barriers

to DFI if they are concerned that the DFI might adversely affect local competitors or the
environment (Madura, 2013). When an MNC considers a specific form of DFI, it must measure

the potential benefits, including possible diversification benefits and host government incentives.

It must also consider country barriers that make the DFI more risky. If its initial assessment leads

to a conclusion that DFI might, be worthwhile, it can then apply a capital budgeting analysis to

determine whether DFI is feasible (Madura, 2013).

Reference
Madura, J. (2013). International Financial Management (Vol. 12). Cengage Learning:
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