Chapter 13: Direct Foreign Investment

Question 1

Motives for DFI

Answer 1

Revenue Related
Cost Related

Question 2

Revenue Related Motives for DFI

Answer 2

• Attract new sources of demand
  ○ DFI in countries experiencing economic growth to benefit from increased demand for goods/services (resident higher income levels)
• Enter profitable market
  ○ When similar industries are generating very high earnings in a particular country, an MNC may decide to sell its own products in those markets.
• Exploit monopolistic advantages
• React to trade restrictions
  ○ Defensive method to circumvent trade barriers
• Diversify Internationally
  ○ By diversifying sales (and possibly even production) internationally, a firm can make its net cash flows less volatile.

Question 3

Cost Related Motives for DFI

Answer 3

• Fully benefit from economies of scale
  ○ Economies of scale: Lower average cost per unit resulting from increased production.
  ○ Or if produce high cost website but reach foreign markets
• Use foreign factors of production
  ○ Labor and land costs cheaper
• Use foreign raw materials
  ○ Develop the product in the country where the raw materials are located.
  ○ Lower transportation costs
• Use/learn foreign technology
• React to exchange rate movements
  ○ When a firm perceives that a foreign currency is undervalued, the firm may consider FDI in that country, as the initial outlay should be relatively low.

Question 4

Incentives to encourage DFI

Answer 4

• tax breaks on the income earned there
  
  • rent-free land and buildings
  • low-interest loans
  • subsidized energy
    reduced environmental regulations

Question 5

Barriers to DFI

Answer 5

• Protective barriers — Agencies may prevent an MNC from acquiring companies if they believe employees will be laid off
• “Red Tape” barriers — Procedural and documentation requirements
• Industry barriers — Local firms may have substantial influence on the government and may use their influence to prevent competition from MNCs
• Environmental barriers — Building codes, disposal of production waste materials, and pollution controls
• Regulatory barriers — Each country enforces its own regulatory constraints pertaining to taxes, currency convertibility, earnings remittance, employee rights, and other policies.
• Ethical differences — A business practice that is perceived to be unethical in one country may be ethical in another.
• Political instability — If a country is susceptible to abrupt changes in government and political conflicts, the feasibility of FDI may be dependent on the outcome of those conflicts.

Question 6

Evaluating DFI opportunities

Answer 6

Identify motives
Capital budgeting (feasible)
International corporate control
Country risk analysis
Capital structure
Long term finance