International Corporate Finance
This article focuses on how multinational corporations decide on whether or not to enter foreign markets and evaluate their performance once they have entered the markets. One of the main questions that the financial team will ask when contemplating whether or not it should go into foreign operations is "what are the benefits?" In order to evaluate its risk-return profile, the multinational corporation will review imperfections in the various markets for goods and services, factors of production, and financial assets that can be created. Two long run investment and financing options (i.e. international capital budgeting and direct foreign investments) are explored, and the results from a study conducted on the how to measure overseas financial performance are reviewed.
Keywords Capital Budgeting; Direct Foreign Investment (DFI); Discounted Cash Flow Techniques; International Business Operations; International Capital Budgeting; International Strategy; Multinational Corporation (MNC)
Finance: International Corporate Finance
One of the focal points for many multinational corporations is to have the ability to perform financial transactions outside of the United States. It is important for these corporations to have the ability to participate in the international trade process. Financial managers of multinational corporations must be aware of the financial techniques involved in the international trade process. Three basic needs of import-export financing are: Guarantee against the risk of a business deal being incomplete, security against foreign exchange dangers, and a way of financing the transactions involved (Eiteman & Stonehill, 1979). Some of the key banking services that are needed include letters of credit, wire transfers, collections, and foreign exchange (Teller Sense, 2003). It is important for organizations to have the ability to wire deposits in a timely manner, have the credibility for banks to provide a letter of credit on its behalf, and collect payments quickly and easily.
"Although the original decision to undertake operations in a particular foreign country may be determined in practice by a mix of strategic, behavioral, and economic decisions, the specific project and all reinvestment decisions should be justified by traditional financial analysis" (Eiteman & Stonehill, 1979, p. 264). One of the main questions that the financial team will ask when contemplating whether or not it should go into foreign operations is "what are the benefits?" In order to evaluate its risk-return profile, the multinational corporation will review imperfections in the various markets for goods and services, factors of production, and financial assets that can be created (Eiteman & Stonehill, 1979).
Two key areas of long term investments and financing are international capital budgeting and direct foreign investments. Although many large multinational corporations with international sales have been the focus of many capital budgeting studies, direct foreign investments are just as important when a multinational corporation is reviewing its long-run investment and financing options. Direct foreign investments deal with market imperfections and behavioral factors which may entice a multinational corporation to invest in a foreign country on a long term or permanent basis. International capital budgeting applies contemporary finance theory and special research into international operations to considerations of techniques by which foreign investment decisions should be made (Eiteman & Stonehill, 1979).
International Capital Budgeting
"Capital budgeting is a financial analysis tool that applies quantitative analysis to support strong management decisions" (Bearing Point, n.d.). Capital budgeting seeks to provide a simple way for the finance department to see the "big picture" of the benefits, costs and risks for a corporation planning to make short term and/or long term investments. Unfortunately, many of the leading methods have experienced problems, especially when an organization is using a standardized template. Examples of potential problems include:
- The benefits, costs, and risks associated with an investment tend to be different based on the type of industry (i.e. technology versus agricultural).
- A corporation may highlight the end results of the return on investment model and the assumptions that support the results versus a balanced analysis of benefits, costs, and risks.
If an organization does not account for the above-mentioned scenarios, there is a possibility for the results to be skewed, which would make the data unusable. This type of error could hinder a project from getting approved. Therefore, it is critical for financial analysts to have a more effective and efficient technique to use. Bearing Point (n.d.) identified several leading practices that organizations are using in order to avoid reporting faulty information. The theme in all of the techniques is that capital budgeting is not the only factor considered. Other quantifiable factors are utilized in order to see the big picture.
- Consider the nature of the request — The type of benefit obtained by the investment will determine the nature of the request. Therefore, it may be beneficial to classify the benefit types into categories such as strategic, quantifiable and intangible.
- All benefits are not created equal — Benefits should be classified correctly in order to properly analyze. There are two types of benefits — hard and soft. Hard benefits affect the profit and loss statement directly, but soft benefits do not have the same affect.
- Quantify risk — Make sure that the risks are properly evaluated. In most cases, risks are neglected. Also, it would be a good idea to build a risk factor into whatever model is utilized.
- Be realistic about benefit periods. Make sure that the expectations are realistic. In the past, corporations have created unrealistic goals for the benefits period by anticipating benefits to come too early and reusing models that reflect the depreciation period for the capital asset.
Although the same theoretical framework applies, capital budgeting analysis of a foreign product can be more complex than the domestic products. Eiteman and Stonehill (1979) identified eight potential complications for the international capital budgeting process. Potential problems included:
- There is a need to distinguish between project cash flows and parent cash flows.
- Financing and remittance of funds to the parent company need to be absolutely identified due to the conflicting tax systems, constraints on financial flows, local norms, and changes in financial markets and institutions.
- Differential rates of national inflation can be important in changing competitive positions and cash flows over time.
- Foreign exchange rate changes which are not matched by differential national inflation rates may alter the value of cash flows from affiliate to parent and vice versa.
- Segmented worldwide capital markets may initiate a chance for financial gain or could cause even more financial losses.
- Terminal value is hard to evaluate due to possible divergent market values of a project to potential buyers from the host, parent, or third countries.
- Political risks may drastically reduce the value of a foreign investment.
Direct Foreign Investment
Investment decisions must be made for both foreign and domestic endeavors. However, the process is more complex when evaluating foreign investment decisions. Foreign investments are usually made with a more complicated set of strategic, behavioral, and economic considerations. In addition, the evaluation phase tends to be longer, more costly, and results in less information on which to evaluate opportunities. Financial assessments...
(The entire section is 3526 words.)