International Business Ch. 20 Vocab/Ideas

Question 1

What Is Financial Management?

Answer 1

Investment decisions –what to finance

Financing decisions –how to finance those decisions

Money management decisions –how to manage the firm’s financial resources most efficiently

Question 2

What Is Accounting?

Answer 2

Accounting is more complex for international firms because of differences in accounting standards from country to country
differences make it difficult for investors, creditors, and governments to evaluate firms
It is difficult to compare financial reports from country to country because of national differences in accounting and auditing standards

Question 3

What Determines National Accounting Standards?

Answer 3

Several variables influence the development of a country’s accounting system including:
the relationship between business and the providers of capital
political and economic ties with other countries
the level of inflation
the level of a country’s economic development
the prevailing culture in a country

Question 4

How Do Providers Of Capital Influence Accounting?

Answer 4

A country’s accounting system reflects the relative importance of each constituency as a provider of capital

accounting systems in the U.S. and Great Britain are oriented toward individual investors

Switzerland and Germany focus on providing information to banks

Question 5

How Do Political And Economic Ties Influence Accounting?

Answer 5

Similarities in accounting systems across countries can reflect political or economic ties
the U.S. accounting system influences the systems in the Philippines

in the European Union, countries are moving toward common standards

the British system of accounting is used by many former colonies

Question 6

How Do Levels of Development Influence Accounting?

Answer 6

Developed nations tend to have more sophisticated accounting systems than developing countries
larger, more complex firms create accounting challenges
providers of capital require detailed reports

Many developing nations have accounting systems that were inherited from former colonial powers
lack of trained accountants

Question 7

What Are Accounting And Auditing Standards?

Answer 7

Accounting standards are rules for preparing financial statements
they define useful accounting information

Auditing standards specify the rules for performing an audit
the technical process by which an independent person gathers evidence for determining if financial accounts conform to required accounting standards and if they are also reliable

Question 8

Why Are International Accounting Standards Important?

Answer 8

The growth of transnational financing and transnational investment has created a need for transnational financial reporting
many companies obtain capital from foreign providers who are demanding greater consistency

Standardization of accounting practices across national borders is probably in the best interests of the world economy
will facilitate the development of global capital markets

Question 9

Why Are International Accounting Standards Important?

Answer 9

The International Accounting Standards Board (IASB) is a major proponent of standardization of accounting standards
most IASB standards are consistent with standards already in place in the U.S.
by 2011, 100 nations have adopted IASB standards or permitted their use in reporting financial results
the EU has mandated harmonization of accounting principles for members
there soon could be only two major accounting bodies with substantial influence on global reporting
FASB in the U.S. and IASB elsewhere

Question 10

How Does Accounting Influence Control Systems?

Answer 10

The control process in most firms is usually conducted annually and involves three steps:
Subunit goals are jointly determined by the head office and subunit management

The head office monitors subunit performance throughout the year

The head office intervenes if the subsidiary fails to achieve its goal, and takes corrective actions if necessary

Question 11

How Do Exchange Rates Influence Control?

Answer 11

Budgets and performance data are usually expressed in the corporate currency
normally the home currency
facilitates comparisons between subsidiaries
but, can create distortions in financial statements

Question 12

How Do Exchange Rates Influence Control?

Answer 12

The Lessard-Lorange Model

Firms can deal with the problems of exchange rates and control in three ways

1. The initial rate
   the spot exchange rate when the budget is adopted
2. The projected rate
   the spot exchange rate forecast for the end of the budget picture
3. The ending rate
   the spot exchange rate when the budget and performance are being compared

Question 12

Why Separate Subsidiary and Managerial Performance?

Answer 12

Subsidiaries operate in different environments which influence profitability

-the evaluation of a subsidiary should be kept separate from the evaluation of its manager

-A manager’s evaluation should
consider the country’s environment for business
take place after making allowances for those items over which managers have no control

Question 13

What Is Financial Management?

Answer 13

Good financial management can create a competitive advantage
reduces the costs of creating value and adds value by improving customer service

Decisions are more complex in international business
different currencies, tax regimes, regulations on capital flows, economic and political risk, etc.

Question 14

How Do Managers Make Investment Decisions?

Answer 14

Financial managers must quantify the benefits, costs, and risks associated with an investment in a foreign country

To do this, managers use capital budgeting
involves estimating the cash flows associated with the project over time, and then discounting them to determine their net present value

If the net present value of the discounted cash flows is greater than zero, the firm should go ahead with the project

Question 15

Why Is Capital Budgeting More Difficult For International Firms?

Answer 15

Capital budgeting is more complicated in international business because:
a distinction must be made between cash flows to the project and cash flows to the parent company

of political and economic risk

the connection between cash flows to the parent and the source of financing must be recognized

Question 16

What Is The Difference Between Project And Parent Cash Flows?

Answer 16

Cash flows to the project and cash flows to the parent company can be quite different -

Parent companies are interested in the cash flows they will receive, not the cash flows the project generates
received cash flows are the basis for dividends, other investments, repayment of debt, and so on

Cash flows to the parent may be lower because of host country limits on the repatriation of profits, host country local reinvestment requirements, etc.

Question 17

How Does Political Risk Influence Investment Decisions?

Answer 17

Political risk - the likelihood that political forces will cause drastic changes in a country’s business environment that hurt the profit and other goals of a business
higher in countries with social unrest or disorder, or where the nature of the society increases the chance for social unrest

Political change can result in the expropriation of a firm’s assets, or complete economic collapse that renders a firm’s assets worthless

Question 18

How Does Economic Risk Influence Investment Decisions?

Answer 18

Economic risk - the likelihood that economic mismanagement will cause drastic changes in a country’s business environment that hurt the profit and other goals of a business

The biggest economic risk is inflation
reflected in falling currency values and lower project cash flows

Question 19

How Can Firms Adjust For Political And Economic Risk?

Answer 19

Firms analyzing foreign investment opportunities can adjust for risk by:

raising the discount rate in countries where political and economic risk is high

lowering future cash flow estimates to account for adverse political or economic changes that could occur in the future

Question 20

How Do Firms Make Financing Decisions?

Answer 20

Firms must consider two factors:

How the foreign investment will be financed
the cost of capital is usually lowest in the global capital market
but, some governments require local debt or equity financing
firms that anticipate a depreciation of the local currency, may prefer local debt financing

How the financial structure (debt vs. equity) of the foreign affiliate should be configured
need to decide whether to adopt local capital structure norms or maintain the structure used in the home country

Most experts suggest that firms adopt the structure that minimizes the cost of capital, whatever that may be

Question 21

What Is Global Money Management?

Answer 21

Money management decisions attempt to manage global cash resources efficiently

Firms need to:

Minimize cash balances - need cash balances on hand for notes payable and unexpected demands

cash reserves are usually invested in money market accounts that offer low rates of interest

when firms invest in money market accounts they have unlimited liquidity, but low interest rates

when they invest in long-term instruments they have higher interest rates, but low liquidity
Reduce transaction costs - the cost of exchange

every time a firm changes cash from one currency to another, they face transaction costs

Question 22

What Is Global Money Management?

Answer 22

Key Considerations:
Most banks also charge a transfer fee for moving cash from one location to another

Multilateral netting can reduce the number of transactions between subsidiaries and the number of transaction costs

Question 23

How Can Firms Limit Their Tax Liability?

Answer 23

Every country has its own tax policies
most countries feel they have the right to tax the foreign-earned income of companies based in the country

Double taxation occurs when the income of a foreign subsidiary is taxed by the host-country government and by the home-country government

Question 24

How Can Firms Limit Their Tax Liability?

Answer 24

Taxes can be minimized through:

Tax credits - allow the firm to reduce the taxes paid to the home government by the amount of taxes paid to the foreign government

Tax treaties - agreement specifying what items of income will be taxed by the authorities of the country where the income is earned

Deferral principle - specifies that parent companies are not taxed on foreign source income until they actually receive a dividend

Tax havens - countries with a very low, or no, income tax – firms can avoid income taxes by establishing a wholly-owned, non-operating subsidiary in the country

Question 25

How Do Firms Move Money Across Borders?

Answer 25

Firms can transfer liquid funds across border via:
Dividend remittances

Royalty payments and fees

Transfer prices

Fronting loans

Question 26

What Are Dividend Remittances?

Answer 26

Paying dividends is the most common method of transferring funds from subsidiaries to the parent

The relative attractiveness of paying dividends varies according to:

tax regulations – high tax rates make this less attractive

foreign exchange risk – dividends might speed up in risky countries

the age of the subsidiary – older subsidiaries remit a higher proportion of their earning in dividends

the extent of local equity participation – local owners’ demands for dividends come into play

Question 27

What Are Royalty Payments?

Answer 27

Royalties - the remuneration paid to the owners of technology, patents, or trade names for the use of that technology or the right to manufacture and/or sell products under those patents or trade names
can be levied as a fixed amount per unit or as a percentage of gross revenues

Most parent companies charge subsidiaries royalties for the technology, patents or trade names transferred to them

Question 28

What Are Royalty Fees?

Answer 28

A fee is compensation for professional services or expertise supplied to a foreign subsidiary by the parent company or another subsidiary
royalties and fees are often tax-deductible locally

Question 29

What Are Transfer Prices?

Answer 29

Transfer prices - the price at which goods and services are transferred between entities within the firm

Transfer prices can be manipulated to:
Reduce tax liabilities by shifting earnings from high-tax countries to low-tax countries

Move funds out of a country where a significant currency devaluation is expected

Move funds from a subsidiary to the parent when dividends are restricted by the host government

Reduce import duties when ad valorem tariffs are in effect

Question 30

What Makes Transfer Prices Unattractive?

Answer 30

Using transfer pricing can be problematic because:

Governments think they are being cheated out of legitimate income

Governments believe firms are breaking the spirit of the law when transfer prices are used to circumvent restrictions of capital flows

It complicates management incentives and performance evaluation

Question 31

What Are Fronting Loans?

Answer 31

Fronting loans are loans between a parent and its subsidiary channeled through a financial intermediary, usually a large international bank

Firms use fronting loans to:
circumvent host-country restrictions on the remittance of funds from a foreign subsidiary to the parent company

gain tax advantages