International Financial Management

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Issues of IFM

Investing Decisions
Financing Decisions
Money Management Decisions

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Investing Decisions
Capital Budgeting
Project and Parent Cash Flow
Incorporating Risk
Political Risk
Economic Risk

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Capital Budgeting Process
1. Future cash inflows are estimated
2. Appropriate discount rate is determined
3. Estimated future cash inflows are discounted
4. Present value of future cash inflows are
compares with the cost of the project
5. Projects arte ranked in the order of Net
Present Value
6. Project with the highest NPV is selected

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Multinational Capital
Budgeting. Features
1. Involves multiple currencies
2. Involves multiple tax rates and tax systems
3. Subject to foreign political risk
4. Subject to capital flow restrictions
5. Project specific subsidies provided by the
host government
6. Project specific penalties imposed by the host
government
7. Restrictions on repatriating income

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MCB – Two perspectives

Perspective of the parent

Perspective of the subsidiary
The cash flow under the two
perspectives will be different
So the feasibility of the project
changes with the change in the
perspective.

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 Reasons for Change in Cash Flow
1. Existence of Tax Differences:-
If tax rates on fund remittances are high,
the project may be feasible from the view
point of the subsidiary and may not be
viable form the point of view of the parent
2. High Fees:
When the parent charges high fees from
the subsidiary, the net income of the
subsidiary decreases and therefore it
become unviable from subsidiaries
perspective, but viable from parent’s
perspective

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Reasons for Change in Cash Flow
3. Remittance Restrictions:-
When there are restrictions on
remittances, the project becomes unviable
from parent’s perspective though viable
from ht perspective of the subsidiary
4. Exchange Rate variations:-
If the parent's currency appreciates, the
amount remitted to the parent may decline
(in terms of parent’s currency) and the
project becomes unviable, though it is
viable in the perspective of the subsidiary

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Reasons for Change in Cash Flow

5. Effect on sales of other divisions:

Because of the foreign investment
the existing export of a
multinational firm decrease. While
evaluating the project from the
perspective of the parent the loss
due to decline in exports also should
be considered

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Capital Budgeting Techniques
Payback period (PBP)
Average Rate of Return (ARR)
Net Present Value (NPV)
Profitability Index (PI)
Internal Rate of Return (IRR)

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Net Present Value (NPV)
It is the most popular method of
project evaluation
The present value of future cash
inflows are compared with the cost
of the project

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NPV for International Evaluation
International projects have certain
special features such as blocking of
funds, Cannibalization and sales creation,
different levels of taxation, opportunity
cost, transfer pricing, fees and royalties,
etc.,
The major draw back in using NPV for
evaluation of international projects is
that the risk perceptions of various types
of cash flows cannot be incorporated
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 Adjusted Present Value(APV)
In APV technique, the complexities
found in investment overseas are
separately accounted for.
In this method each type of cash
flow is discounted separately using
different discount rates

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Incorporating Risk
To incorporate political and
economic risk –
A higher discount rate is
generally used

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Financing Decisions

Source of Financing
Foreign Issue, Euro Issue
Financial Structure
Debt-Equity Composition
Method Financing
Depository Receipts, Equity, Bond,
FCCB, ECB

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Global Money Management
Objectives
Efficiency
Tax

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Efficiency Objectives
Minimising cash balance
Reducing Transaction Cost

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Attaining the Objectives
Dividend remittances
Royalty payments
Transfer prices
Fronting Loans (A loan between a
parent and its subsidiary channelled
through a financial intermediary)

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Techniques
Centralised Depositories
Multilateral Netting

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Cash Management
Cash flow management is a part of
short term financial management
It is an integral part of
international financial
management

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Cash Management - Objectives
1. To allocate short-term investments
and cash balance holdings between
currencies and countries to maximize
overall corporate returns
2. To borrow in different money markets
to achieve the minimum cost
3. Reduce the tax

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 Cash Management –
Two broad issues
1. The Investment and Borrowing Criteria
 Whether a company should invest or borrow in
domestic versus foreign currency
2. Centralised Vs. Decentralised cash
management
• Whether a company with receipts and payments in
different countries and currencies should manage
working capital locally or centrally

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The Investment and Borrowing
Criteria Factors to be considered

1. The expected change in the

foreign exchange rate
2. The current and future interest
rate
3. The transaction cost

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 The Investment and Borrowing

Determining the currency of

investment
Determining the currency of
borrowing

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 Determining the currency of
investment
Investors should be indifferent
between home- and foreign-
currency denominated securities, if
the home-currency interest rate
equals the foreign-currency interest
rate plus the annualised forward
exchange premium/discount on the
foreign currency

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 Determining the currency of
investment
Investors should invest in the
home currency
when the domestic-currency interest
rate exceeds the sum of the foreign –
currency rate plus the forward
exchange premium/discount
and invest abroad
when the domestic currency rate is
less than this sum
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Determining the currency of
borrowing 1
The borrowing criterion is the same as the
investment criterion with the inequality
reversed. That is,
Borrowers should be indifferent between
home- and foreign-currency denominated
securities if
the home-currency interest rate equals the
foreign-currency interest rate plus the
annualised forward exchange
premium/discount on the foreign currency
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 Determining the currency of
borrowing 2
Borrowers should borrow in the home
currency
when the domestic-currency interest rate is less than
the sum of the foreign –currency rate plus the
forward exchange premium/discount and
borrow from abroad
when the domestic currency rate is higher than this
sum

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Impact of Transaction cost on
borrowing and lending
Transaction costs on foreign exchange
tend to favour the choice of domestic
currency investments
Levi 419
Foreign currency borrowings are
discouraged by borrowing-lending
spreads
Levi 421

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 Centralised Vs. Decentralised
Cash management
A multinational corporation with
subsidiaries in different parts of the
world may have cash flows in a variety
of currencies and countries.
It can leave cash management to
individual subsidiaries or
have a centralised cash management
system

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 Advantages of Centralised Cash
management System

Netting
Leading and Lagging
Currency Diversification
Pooling
Security Availability and Efficiency
of Collections

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Netting
Netting involves
the cash management centre nets out
receivables against payables, and only the
net cash flows are settled among different
units of the corporate family
Netting need not be confined to intra-
corporate transactions. Transactions
with third parties can also be
incorporated

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 Leading and Lagging
Leading and lagging involves
the movement of cash inflows and outflows
forward and backward in time so as to permit
netting and achieve other goals
The opportunities for leading and lagging
are limited by preference of the other party
When transactions are between divisions of
the same multinational the scope for
leading an lagging is considerable
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 Currency Diversification
A portfolio of inflows and outflows in different
currencies will have a smaller variance of value
than the sum of variances of the values of the
individual currencies.
The adverse effect from exchange rate
variations in one currency will more or less will
be compensated by the favourable variations
in the exchange rate of one or more other
currencies

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 Pooling
1. Pooling occurs when cash is held as well as
managed centrally
2. The advantage of pooling is that cash needs can
be met wherever they occur without having to
keep precautionary balances in each country
3. Uncertainties and delays in moving funds to
where they are needed require that some balance
be maintained everywhere
4. With pooling, a given probability of having
sufficient cash to meet liquidity needs can be
achieved with smaller holdings.
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Security Availability and Efficiency in
Collections
If the centralisation occurs in a major
international financial center like
London or New York, there are
additional advantages in terms of:
1. A broader range of securities that
are available and
2. An ability to function in an
efficient financial system
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 Disadvantages of Centralised Cash
management
Some funds have to be held in each
subsidiary to meet unforeseen
payments since banking system in many
developing countries do not permit
rapid transfers of funds
Some payments are to be made on the
spot for which purpose local banks have
to be used and local banking
relationships are essential
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 Factors affecting the Location of Cash

Factor Implication

Absence of Forward Keep funds in the currency received if an

markets anticipated future need exists
Transaction costs Keep funds in the currency received

Political risk Move funds to the home market

Liquidity needs Keep funds in the currency most likely to

be needed in the future
Withholding tax Avoid countries whose withholding rates
exceed the domestic tax rate
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Tax Issue
Double Taxation (Tax paid in both the
countries)
Tax on repatriation (Tax on only that
incomer which is transferred to another
country)

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Assignment
Read the closing case in P.856 and
prepare a write up in two pages
Read question No.4 in page 855
and write an answer in one page
Date of submission – 13/12/2008

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