Daniel Schenk Maastricht University 9 February 18

International Financial Management

Chapter 1 – An Introduction to Multinational Finance

1.1 The Goals of the Multinational Corporation (MNC)

Stakeholder – Those with an interest (stake) in the firm.
Primary goal of the firm is to maximise shareholder wealth, but there are also other
stakeholders with interest in the firm: suppliers, customers, debtholders, managers, business
partners, employees, and society.

Value of revenues is
allocated to operation
expenses, governments,
suppliers of debt and
equity capital.

The objectives of these

stakeholders are seldom
the same.

Agency costs – Any loss

in value from conflicts of
interest between managers
and other stakeholders,
particularly equity shareholders. Include costs of contracting and monitoring, typically born by
shareholders.

Nations determine the nature of the playing fields on which MNCs operate and differ in the
extent to which they protect each of the stakeholders.

1.2 The Challenges of Multinational Operations

Multinational operations can create additional costs in every business discipline as their
exposure to risk is increased.
Risk exposure – When assets or liabilities can change in value with unexpected changes in
business conditions.
Country risk – Risk that the business environment in a host country or the host country’s
relations with another country will unexpectedly change.
Political risk – Risk that the business environment in a host country will unexpectedly
change due to political events when local political forces influence the business environment.
Financial risk – Risk of unexpected change in the financial or economic environment of a
host country, including currency risk.
Currency risk – Also called foreign exchange, forex, FX risk, is the risk of unexpected
changes in currency values affecting the value of the firm.

1.3 The Opportunities of Multinational Operations

Discounted cash flow – Approach to valuation: value of an asset or liability is equal to the
present value (PV) of expected future cash flows discounted at an appropriate risk-adjusted
discount rate.
𝐸[𝐶𝐹𝑡 ]
𝑉=∑ [ ]
𝑡 (1 + 𝑖)
𝑡

If a corporate decision has no impact on the firm’s expected future cash flows or discount
rate, the decision has no impact on the value of the firm.

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Daniel Schenk Maastricht University 9 February 18

Multinational Investment Opportunities

Investment opportunity set – Set of investments available to the firm.
Firm’s investment objective is to identify the set of assets that maximises the value of the firm
to its key stakeholders – Maximise the PV of future operating cash flows (accepting projects
with an expected return that exceeds investors’ required return).
MNCs have many opportunities to enhance revenues and reduce costs compared to local
firms:
• Global marketing – Provides access to markets competitors cannot reach.
• Access to low-cost labour or raw materials – Reducing costs and ensuring supplies.
• Flexibility in global site selection – In terms of location and timing of investments.
• Flexibility in sourcing and production – Shift inputs in response to currency movements or
other factors.
• Economies of scale and scope – When the size results in lower per-unit costs as costs
are spread over a larger output and when joint production results in lower per-unit costs.
• Economies of vertical integration – When firms lower costs through control of a vertically
integrated supply chain.
• Multinational tax planning – Operations in more than one tax jurisdiction leads to more
flexibility in managing tax burden.

Strategies for preserving or enhancing operating cash flows:

• Follow the customer – Learn nuances of operating in foreign countries, then beginning to
pursue foreign clients as well.
• Lead the customer – Attract foreign companies into domestic market to solidify relations.
• Follow the leader – Acquiring similar foreign assets to reduce the threat of falling behind.
• Go local – Build capacity in foreign markets to avoid quotas or tariffs on imported goods.

Multinational Financial Opportunities

The objective of financial policy is to maximise the value of the firm through financing choices.
Financial decisions include mix of debt and equity capital, debt’s maturity structure, markets
in which capital is denominated and issues, and financial risk management.
Liquidity – The ease with which an asset can be exchanged for cash (capturing an asset’s
value).
Illiquidity – If it takes time to convert an asset into cash or there is a loss of value in the
conversion.

Perfect Financial Markets and Concepts of Market Efficiency

In a perfect financial market, rational investors have equal access to market prices and
information in a frictionless market.

Operational efficiency – There are no drains on funds as they are transferred from one use
to another (first assumption).
Informational efficiency – A market in which prices fully reflect all relevant information (last
three assumptions).
Allocational efficiency – Promoted by operational and informational efficiency and is an
efficient allocation of capital towards its most productive uses: basic objective of any financial
market, greatest when there is high liquidity and transaction volume in freely traded assets.

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Daniel Schenk Maastricht University 9 February 18

Arbitrage – Simultaneous purchase and sale of the same or equivalent asset in order to
ensure a profit with no net investment at risk.

Implications of Perfect Financial Markets

A firm’s financial policy is irrelevant in a perfect financial market and does not affect firm
value.
Financial market imperfections are more prominent internationally, so MNCs have more
opportunities:
• Hedging policy – Create value by reducing drains on operating cash flows.
• Cost of capital when there are capital flow barriers – Lowering cost of capital by selling
debt or equity to foreign investors.
• Reducing taxes through multinational operations.
• Barriers to the free flow of capital across international markets.
• Currency risk and cost of capital.

Multinational Opportunities and Firm Value

Firms accept its most

lucrative projects first,
so expected returns
fall as more capital is
invested. Firms draw
upon their lowest cost
sources of funds first,
so cost of capital is an
increasing function of
the capital budget.

1.4 Financial Management of the Multinational Corporation

Culture influences the conduct of business, creating cross-border differences in financial,
economic, political, regulatory, accounting, and tax environments.
The multinational financial manager must be knowledgeable in all of the disciplines of
business and finance, and sensitive to local norms and values.

1.5 Summary
MNCs depend on its managers’ abilities to recognise and exploit imperfections in national
markets for products and factors of production, and to work effectively within the political and
economic constraints imposed by host governments.