Lecture 10

Question 1

What is FDI and why do MNCs engage in it?

Answer 1

Foreign Direct Investment is something MNCs engage in typically to improve profitability, enhance shareholder wealth.

FDI involves obtaining at least 10% ownership in a legally recognized foreign entity

Question 2

What are the three motives behind FDI?

Answer 2

Firm specific advantages:
-Proprietary technology
-Managerial marketing skills
-Trademarks
-Economies of scale

Internalization advantages:
-Higher enforcement costs
-Buyer uncertainty over value
-Need to control production

Country specific advantages:
-Natural resources
-Technology
-Labor force
-Tax
-Trade barriers

Question 3

How is FDI viewed by the host government?

Answer 3

The first level of FDI is between governments. The negotiations may be bilateral or unilateral.

The second level of relationship is between governments and MNCs. Governments want technology, employment, taxes and managerial knowledge. MNCs’ interests in
the host country are purely financial.

Question 4

Please list and describe some of the key differences between how a parent company and a subsidiary in another may regard capital budgeting

Answer 4

Tax differentials - the tax rates on earnings may be different between subsidiary and
parent’s governments

Restricted remittances - part of the earnings may be retained in the subsidiary’s country

Excessive remittances - the parent may demand too much from the subsidiary

Exchange rate movements - – the currency risk makes the remittance uncertain for the
parent

Question 5

What can political risk be classified into?

Answer 5

Macro risk: where all foreign operations are affected by adverse political development in the host country

Micro risk: where only selected areas of foreign business operations or particular foreign firms are affected

Transfer risk: arises from uncertainty about cross-border flows of capital, payments, know-how, and
the like.

Operational risk: associated with uncertainty about the host country’s policies affecting the local operations of MNCs.

Control risk: arises from uncertainty about the host country’s policy regarding ownership and control
of local operations

Question 6

Please provide the NPV formula

Answer 6

NPV = IO + Sum (CFt)/(1+r)^t + TVn/(1+r)^n

-Initial investment + cash flows discounted at r^t + Terminal value discounted at r^n

Question 7

What is the formula for CFt

Answer 7

CFt = NIt + Dept + It(1-t)

NI: Net income
Dep: Depreciation
It: Interest expense
(1-t) : 1- corporate tax rate

Question 8

Please provide the APV formula, explaining every step

Answer 8

To obtain the APV we first restate the CF.

CFt = OCF(1-τ) + τDept
- OCF(1-τ) is the operating cash flow after tax
- τDept is the tax shield benefit from depreciation. τ is tax rate and Dept is depreciation

Weighted avg. cost capital (WACC):
R = WdRd(1-τ) + WeRe

Adjusted present value:
APV = Look up formula in slides

Question 9

International capital budgeting - what additional cconsiderations do managers here have to make and what may be the advantage

Answer 9

Capital budgeting from the parent’s perspective:

Restrictions on fund transfers: - foreign government may require certain proportion of the subsidiary earnings remain in the country

Tax laws:
- the tax laws on earnings generated by a foreign subsidiary or remitted to the parent vary among
countries

Exchange rate fluctuations:
- earnings in the subsidiary’s local currency need to be converted into the parent’s
currency

Please see slide for APV formula