DQ: Economics #6

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chapter_13.ppt

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Chapter 13

The Multinational Corporation and Globalization

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Outline

Globalization
Opportunities of international expansion
Risks faced by a multinational corporation
Exchange rates and exchange rate hedging
Foreign direct investment
Multinational capital budgeting
Repositioning of funds
Multinational transfer pricing

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Learning Objectives

Understand how supply and demand are affected in different countries around the world
Define the exchange rate and identify several methods of hedging
Understand multinational capital budgeting and explain how it differs from capital budgeting of a domestic corporation
Show how changing transfer prices can benefit a corporation

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Globalization

One of the main reasons a company wants to operate globally is to take advantage of new growth opportunities
Expand to serve new markets (e.g. food products)
Take advantage of new suppliers (manufacturing and back office services)

In looking at market opportunities, firms often look at international expansion.

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Globalization

Multinational corporations face the same opportunities and problems as a domestic corporation, but also face additional challenges:

Fluctuations in currencies
Different rules and regulations
Different tax systems
Tariffs and other restrictions
Different costs of production
Different cultures, languages, and business practices

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Globalization

The term ‘globalization’

Results in a closer integration of the countries of the world – especially the increased level of trade and movements of capital – brought on by lower costs of transportation and communication.

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Risks Faced by MNCs

Multinational corporation risk: risks that are present only because it transacts business across national borders

Exchange rate risk: results from changes in exchange rates

The multinational corporation faces all the categories of risk of domestic firms-but also additional risk due to international circumstances.

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Risks Faced by MNCs

Other risks faced by the MNC
blockage of funds and capital controls
differences in cultural and religious philosophies
ownership restrictions
human resource restrictions
intellectual property
discrimination
red tape and corruption
internal and external wars
changes in government

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Exchange Rates

Exchange rate: price of one country’s currency in terms of another country’s

May be quoted in terms of the domestic or foreign currency

e.g. Є1/$1.40 or $1/ Є0.714

Hedging: various ways that companies can protect themselves from a potential loss from currency fluctuation

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Exchange Rates

Hedging techniques:

Offsetting Transactions: export goods of the same amount to the same country from which it imported, in the same period of time
Forward Market: permits a company to buy or sell currency at a specific rate at a specific time, customized to its needs
Futures Market: similar to forwards, but on a standardized public exchange (set amounts, maturing on certain days)

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Exchange Rates

Hedging techniques:

Currency Options: give the holder the right to buy or sell an amount of currency at a specified price during a certain period of time

Currency Swaps: companies swap currencies when they expect a offsetting cash flow from other sources in their respective countries

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Foreign Direct Investment

Foreign direct investment (FDI): acquiring ownership rights in foreign fixed assets or existing firms, or establishing foreign subsidiaries with their own infrastructure

This has been especially evident in the automotive industry-foreign firms have located manufacturing facilities in the US, and US firms have located plants outside the US.

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Foreign Direct Investment

Reasons for FDI
Increase its earning and increase the value of the company

Foreign country may impose import restrictions

Take advantage of economies of scale, as well as lower production and transportation costs

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MNC Capital Budgeting

Similar process as for a domestic company, but must take into consideration several extra variables

intercompany fund flows: cash flows between parent to subsidiary

inflation rates: may differ in the country of the parent and of the subsidiary

exchange rates: exchange rate between the parent and subsidiary country will change during the project period

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MNC Capital Budgeting

Tax differences: many types can differ between countries
Income tax rates
Tax on remittances to the parent’s country
Double taxation on subsidiary profit and remittance to parent, offset by foreign tax credit

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MNC Capital Budgeting

Cash flows: cash flows received and recorded by the parent may differ substantially from those in the subsidiary’s country

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MNC Capital Budgeting

Cost of capital: difference in cost of capital for parent and subsidiary

Final project valuation: differences are so significant that a project is acceptable in one country and not in the other

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MNC Capital Budgeting

Repositioning of Funds

Examples:

royalties and license fees can be used to channel funds to those areas of the company where they may be used most profitably
dividend payments to the parent
tax rates on distributed and undistributed earnings
taxes levied on dividends transmitted to the parent
re-invoicing centers

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MNC Transfer Pricing

Multinational transfer pricing: prices for products or services that are transferred from the parent company to the subsidiary or among subsidiaries

Can affect a transfer of funds by charging high or low prices

Can affect a company’s profitability

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MNC Transfer Pricing

Tax liability due to a change in transfer price

DT = (Q · DP · te) – (Q · DP · tm)

DT = change in total tax bill

Q = quantity of products shipped by

E (exporter) to M (importer)

DP = change in the price of the product

te = tax rate in the exporting country

Tm = tax rate in the importing country

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MNC Transfer Pricing

Internal Revenue Code section 482 gives IRS authority to ‘shift around income and expense figures to arrive at what the government considers a more equitable result’.

IRS requires transfer pricing to be done on an ‘arm’s length’ relationship.
Developing countries are becoming more active in the area of regulating transfer pricing

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Summary

A multinational corporation must compete not just domestically but worldwide.
The firm must consider the demand for their products, the cost of supplies, their productivity, and changes in technology.
An MNC must consider economic factors, political factors, and social and cultural factors in their business decisions.
Transfer pricing can be used to achieve higher profits, but governments are monitoring this activity more closely.