international business

Wendy Jeffus

Harvard Summer School

International Business

Introduction Team Evaluations Due! Chapter 18: Global Human Resources

Management– Vineet Garg: "HR services Outsourcing by P&G to IBM"

Chapter 19: Accounting in the International Business

Chapter 20: Financial Management in the International Business

Wendy Jeffus


Chapter 18: Global Human Resources Management

IBM Thinkpad $2004 Lenovo purchased IBM’s PC division for

$1.75B.

Moved global headquarters to New YorkAcquired 4,000 employees (2,400 in the U.S.)Appointed Stephen Ward the former head of IBM’s PC division as the CEO of Lenovo

http://www.lenovo.com/planetwide/select/selector.html

Human Resource Management Four major tasks of HRM

– Staffing policy Who do you hire?

– Management training and development How do you train them?

– Performance appraisal How do you critique their performance?

– Compensation policy What should you pay them?

HRM Strategic role: HRM policies should be congruent

with the firm’s strategy and its formal and informal structure and controls

Summer 2006 Intern trip to Sea World San Antonio

Source: Company websites

International HRM Task complicated by profound differences

between countries:– Labor Markets

Skilled labor, average workday, influence of unions,

– Culture Role of women, role of religion, distance between the boss

and the employee, emphasis on time!

– Legal Handshake, legal support, labor laws

– Economic Systems Fixed vs. floating currencies

International Human Resource Mgmt.

HR plays a large role in an organization’s architecture

Staffing Policy Staffing policy

– Selecting individuals with skills to do a particular job– But also a tool for developing and promoting

corporate culture

3 types of Staffing Policy

Source: Company website

1. Ethnocentric Policy Key management positions filled by parent-

country nationals (belief: Home country skills are superior)

Advantages:– Overcomes lack of qualified managers in host nation– Unified culture– Helps transfer core competencies

Disadvantages:– Produces resentment in host country– Can lead to cultural shortsightedness

2. Polycentric Policy Host-country nationals manage subsidiaries Parent company nationals hold key headquarter

positions (belief: each host country is unique) Advantages:

– Alleviates cultural shortsightedness– Inexpensive to implement– Helps transfer core competencies

Disadvantages:– Limits opportunity to gain experience of host country nationals

outside their own country– Can create gap between home and host country operations

3. Geocentric Policy Seek best people, regardless of nationality (belief: there

are both similarities and differences) Advantages:

– Enables the firm to make best use of its human resources– Equips executives to work in a number of cultures– Helps build strong unifying culture and informal management

network Disadvantages:

– National immigration policies may limit implementation– Expensive to implement due to training and relocation– Compensation structure can be a problem

Nestlé: Global HRM Headquarters: Vevey, Switzerland ~250,000 employees, (100 different nationalities) Emphasis on language skills (You must be fluent in English and in

two other languages) All entry level graduate positions featured are international careers.

– Engineering– Nestlé Audit Group– Nestlé Productivity Team– Marketing & Sales

Expatriates at Nestlé make a long-term commitment to carry out a series of two to three year assignments abroad, moving from one country to another.

– International expatriates have the opportunity to work in many locations – mainly in Asia, Africa, Eastern Europe and Latin America.

http://www.nestle.com/Careers/Introduction/Careers.htm

The Expatriate Problem Expatriate: citizens of one country working in

another– Expatriate failure: premature return of the expatriate

manager to his/her home country Cost of failure is high: estimate = 3X the expatriate’s annual

salary plus the cost of relocation.

US multinationals– Inability of spouse to adjust– Manager’s inability to adjust– Other family problems– Manager’s personal or

emotional immaturity– Inability to cope with larger

overseas responsibilities European multinationals

– Inability of spouse to adjust

Japanese Firms– Inability to cope with larger

overseas responsibilities– Difficulties with the new

environment– Personal or emotional

problems– Lack of technical competence– Inability of spouse to adjust

Reasons for Expatriate Failure

Expatriate Failure Rate

<

<

<

Expatriate Selection Reduce expatriate failure rates by improving

selection procedures An executive’s domestic performance does not

(necessarily) equate to his/her overseas performance potential

Employees need to be selected not solely on technical expertise, but also on cross-cultural fluency

1. Self-Orientation– Possessing high self-esteem, self-confidence and mental well-

being

2. Others-Orientation– Ability to develop relationships with host country nationals – Willingness to communicate

3. Perceptual Ability– The ability to understand why people of other countries behave

the way they do– Being nonjudgmental and flexible in management style

4. Cultural Toughness– Relationship between country of assignment and the expatriate’s

adjustment to it

Four Attributes that Predict Success

Training Cultural training:

– Seeks to foster an appreciation of the host country’s culture

Language training: – Can improve expatriate’s effectiveness, aids in

relating more easily to foreign culture, and fosters a better firm image

Practical training: – Ease into the day-to-day life of the host country

Management Development Development:

– Broader concept involving developing manager’s skills over his or her career with the firm

Several foreign postings over a number of years Attend management education programs at regular intervals

Repatriation of Expatriates

Didn’t know what position they hold upon return.

Firm vague about return, role and career progression.

Took lower level job.

Leave firm within one year.

Leave firm within three years

10 20 30 40 50 60 70percent

Management Development & Strategy Development programs designed to increase the

overall skill levels of managers through:– Ongoing management education– Rotation of managers through a number of jobs within

the firm to give broad range of experiences Used as a strategic tool to build a strong unifying

culture and informal management network

Performance Appraisal Problems:

– Unintentional bias Host nation biased by cultural frame of reference Home country biased by distance and lack of experience working

abroad

Expatriate managers believe that headquarters unfairly evaluate and under-appreciate them

In a survey of personnel managers in U.S. multinationals, 56% stated foreign assignment either detrimental or immaterial to one’s career

Compensation Two issues:

1. Pay Should you pay executives in different countries according

to the standards in each country OR equalize pay on a global basis?

2. Method of payment

Compensation in Various Countries

Additional source: US Bureau of Labor Statistics http://www.bls.gov/fls/

Compensation in Various Countries

Typically use balance sheet approach– Equalizes purchasing power to maintain same

standard of living across countries – Provides financial incentives to offset qualitative

differences between assignment locations

Expatriate Pay

Components of Expatriate Pay Base Salary

– Same range as a similar position in the home country Foreign service premium

– Extra pay for work outside country of origin Allowances

– Hardship, housing, cost-of-living, and education allowances Taxation

– Firm pays expatriate’s income tax in the host country Benefits

– Level of medical and pension benefits identical overseas

The Balance Sheet Approach

International Labor Relations Key Issue

– Degree to which organized labor can limit the choices of an international business

Aims to foster harmony and minimize conflicts between firms and organized labor

Concerns of Organized Labor Multinational can counter union bargaining

power with threats to move production to another country

Multinational will keep highly skilled tasks in its home country and farm out only low-skilled tasks to foreign plants– Easy to switch locations if economic conditions

warrant– Bargaining power of organized labor is reduced

Strategy of Organized Labor Lobby for national legislation to restrict

multinationals Attempts to achieve international regulations.

Wendy Jeffus


Chapter 19: Accounting in the International Business

Accounting Information & Capital Flows

Relationship Between Business and Providers of Capital

Three external sources of capital:– Individual investors

Buying shares and bonds

– Banks Loan capital

– Government Make loans or investment

Importance of each varies from country to country

International Standards Efforts to harmonize accounting standards

across countries Formation of International Accounting Standards

Board Members represent 79 countries Responsible for formulating international

accounting standards (IAS) Has issued over 30 IAS

– Voluntary compliance Recognition is growing

Currency Translation The current rate method:

– Exchange rate at the date on the balance sheet is used to translate foreign subsidiary financial statements into home country currency

– Incompatible with ‘historic cost principle’ where the assumption is that the currency is not losing value due to inflation.*

The temporal method: – The foreign subsidiary assets are translated into

home-country currency at the time of purchase of the asset

– Changing exchange rates may mean the balance sheet may not balance!

*Used in Germany, Japan & the U.S. If inflation is high the historic cost principle underestimates a firm’s assets, so the depreciation charges based on these underestimates can be inadequate for replacing assets when they wear out or become obsolete.

Current Rate Method: Example At time = 0 a U.S. firm invests $100,000 in a

Malaysian subsidiary. – Exchange Rate at time 0 = 5MYR/1USD– Subsidiary purchases land with 500,000 ringgit.

Exchange rate at time 1 = 4MYR/1USD– If this new exchange rate is used to convert the value

of the land back into dollars, it will seem that the land has appreciated by 25%!

The new value of 500,000 ringgit in dollars is $125,000!– (500,000MYR ÷ 4MYR/USD)

Temporal Method: Example At time = 0 a U.S. firm invests $100,000 in a

Malaysian subsidiary. – Exchange Rate at time 0 = 5MYR/1USD– Subsidiary purchases land with 500,000 ringgit.

Exchange rate at time 1 = 4MYR/1USD

.

MYR Exchange Rate USD

Cash 500,000 $1 = 5 RM $100,000

Owners’ equity 500,000 $100,000

MYR Exchange Rate USD

Fixed Asset 500,000 $1 = 5 RM $100,000

Translation Gains $25,000

Owners’ equity 500,000 $125,000

Current US Practice Statement 52 “Foreign Currency Translation” Self-sustaining autonomous subsidiary:

– Functional currency is local currency– Balance sheet uses exchange rate at end of financial year– Income statement is financial year average

Integral subsidiary:– Functional currency is US currency– Financial statements use the temporal method– Dangling credit or debit increases or– Decreases consolidated earnings for the period

Firms using multidomestic or international strategies.

Firms using global or transnational strategies.

Transfer Pricing and Control Systems Transfer prices introduce significant distortions

into the control process Transfer price must be taken into account when

setting budgets and evaluating a subsidiary’s performance

Wendy Jeffus


Chapter 20: Financial Management in International Business

Financial Management Investment Decisions

– What activities should the company finance?

Financing Decisions– How should the company finance selected activities?

Money Management Decisions– How can the firm manage its financial resources most

efficiently?

FMC Produces chemicals and farm equipment with significant overseas

business.– 5,000 employees throughout the world (2,600 in the US). – Segments: 1) Agricultural Products, 2) Specialty Chemicals and 3)

Industrial Chemicals.

Source: 2006 Annual Report, available at www.fmc.com

59% of ‘06Revenuewas outside the U.S.

2007 (Update)

63% of ‘07Revenuewas outside the U.S.

FMC’s Competitive Advantage Offers 3-year pricing contracts available in

multiple currencies.– An in-house bank handles ~$1B in currency

transactions annually to support these prices.

2006 Annual Report: “The primary currencies for which we have exchange rate exposure are the U.S. dollar versus the euro, the euro versus the Norwegian krone, the U.S. dollar versus the Japanese yen and the U.S. dollar versus the Brazilian real.”

The Finance Function Competitive Advantage: through reduced costs

of value creation and/or adding value by improving customer service.

Reduce the costs of creating value by:– Lowering the firm’s cost of capital– Managing foreign exchange risk– Minimizing the firm’s tax burden– Reducing exposure to unnecessary risk– Managing the cash flows and reserves efficiently

Investment DecisionsCapital budgeting:

– Quantifies the benefits, costs and risks of an investment

– Managers can reasonably compare different investment alternatives within and across countries

Three issues complicate the process:1. Project and Parent Cash Flows

2. Adjusting for Political & Economic Risk

3. Risk & Capital Budgeting

1. Project and Parent Cash FlowsProject cash flows may not reach the

parent:– Host country may block cash-flow repatriation– Cash flows may be taxed at an unfavorable rate– Host government may require a percentage of cash

flows to be reinvested in the host country

Blocked Funds Blocked Funds – When the host country’s government prohibits or limits the

remittance of revenues abroad that are earned by foreign corporate investors or by local subsidiaries.

– Revenue can be in the form of overdue bills, royalties and dividends, local earnings, or unpaid trade credits.

– Other forms of revenue: Interest payments in local currencies servicing hard currency loans, licensing fees, advanced payments of import duties, and proceeds from the sale of property.

Why do governments block funds?– To regulate the transfer of FX because of hard currency shortages.

Methods of blocking funds:– Restrictions on the percentage of revenues that can be repatriated, or making the

currency inconvertible. Dealing with Blocked Funds - Examples:

– Xerox used its blocked funds to purchase one of the largest buildings in Bogota, Colombia

– Volkswagen invested its earnings to acquire ranches in Brazil

Source: Haar Jerry, “Managing the problem of blocked funds in Latin America,”International Executive, volume 33, issue 3 p. 7-11.

Corporate Tax Rates

World Perspective: Corporate Tax Rates

Armenia 20.0%Benin 38.0%China 33.0%S. Korea 27.5%Kuwait 55.0%Lebanon 15.0%Pakistan 37.0%Thailand 30.0%United States 35.0%Source: http://www.heritage.org/research/

features/index/country.cfm?id=Benin

http://www.heritage.org/research/features/index/country.cfm?id=benin

2. Adjusting for Political & Economic Risk

Political risk:– Expropriation

Venezuela, 2007

– Social unrest Economic Collapse

– Zimbabwe, 2007

Economic risk– Inflation

Recent Coup d'états 2000: Unsuccessful coup in Fiji. 2000: A coup in Ecuador overthrows the president. 2002: Coup attempt against President Hugo Chávez in Venezuela, within 48 hours, the elected

government regained control of the country. 2003: Failed mutiny and coup attempt in the Philippines. 2004: Attempted coup in the Democratic Republic of Congo . 2004: Failed coup d'état in Chad. 2004: Second attempted coup in the Democratic Republic of Congo. 2004: Attempted coup in Equatorial Guinea. 2004: Coup in Haiti. 2005: King Gyanendra of Nepal overthrows the government, making him the head of government. The

government is reestablished April 24, 2006 after a massive democracy movement. 2006: The Armed Forces of the Philippines allegedly attempted a military coup which lead to a state of

emergency. 2006: The United Front for Democratic Change allegedly attempts to instigate a military coup in Chad. 2006: The Royal Thai Army orchestrates a coup in Thailand that overthrows the Prime Minister while

he is out of the country. 2006: Attempted military coup in Madagascar. 2006: The military of Fiji overthrows the President and Prime Minister in a bloodless coup. 2007: Military coup in Turkey, called 'e-coup' (April 27), delivers an ultimatum to the AKP government

by e-mail.

Source: wikipedia.org

China: KFC KFC was fried by Chinese health inspectors.

– In China, KFC used a cooking oil preservative, that extended the life of frying oil by ten days.

– The Chinese press claimed that the preservative caused cancer.

– The fact that KFC carefully obeyed regional safety standards, and there was no legitimate link between this oil preservative and cancer, did not matter.

Photo Source: www.kfc.com, www.cia.govThe Economist, March 18, 2004 issue: A survey of business in China.

China Product mistrust. Lipton Tea

– Without any evidence, the Chinese media claimed Unilever's Lipton Instant Tea contained cancer-causing fluorides.

– The Chinese Ministry of Agriculture eventually admitted the tea was safe after it was finally tested.

Colgate-Palmolive– Colgate-Palmolive's toothpaste was accused of containing

a carcinogen. – All its toothpaste was cleared from shelves in Shandong

Province. – Though, when under official investigation, Colgate's

toothpaste proven to be harmless by Chinese authorities.

Photo Source: www.lipton.com; www.colgate.com; www.cia.govThe Economist, March 18, 2004 issue: A survey of business in China.

China: Procter & Gamble Procter & Gamble (P&G) in China had its SK-II beauty

products banned for traces of chromium and neodymium.

– Consumers across China dashed to stores for refunds (and even refunds on fake SK-II product) and literally attacked Procter & Gamble's Shanghai offices.

The chromium-neodymium combination is accepted throughout the world; the World Health Organization allows much higher doses in food!

– A month later, the Ministry of Health declared SK-II products safe.

– P&G lost approximately 80 of its 98 distribution outlets.

The Economist, March 18, 2004 issue: A survey of business in China. Photo Source: www.pg.com; www.cia.gov

China Joint-Ventures PepsiCo

– America's PepsiCo’s joint-partner a Sichuan bottler, sold the joint-venture to the local government in exchange for little goodies such as his own car and play money.

Subway– Subway's Beijing sandwich franchise was robbed by their joint-

venture partner for nearly quarter of a million dollars. Subway only runs 30 restaurants, after nine years. They predicted operating 2,000 by this time.

The Economist, March 18, 2004 issue: A survey of business in China. Photo Source: www.pepsi.com; www.subway.com; www.cia.gov

China: Loral Space Loral Space and Communications spent $185

million on ChinaSat 8, a telecommunications satellite project.– Before the US Government asked them to abandon

due to US security issues.

Photo Source: www.loral.com, www. Cia.gov

The Economist, March 18, 2004 issue: A survey of business in China.

India: Enron & GE

The Dabhol Power Project, in 1992, was an Enron and General Electric Capital Corp investment.

– These sponsors starting building this 2.015-mega-watt plant in Maharashtra, India.

– The sponsors spent over $1.2B. One of the biggest projects in India's history.

– When the plant was 23% complete, the newly elected government, rejected Phase Two of the project because the project had “apparently” not been awarded through competitive bidding, power tariffs were too high and it was environmentally risky.

Finnerty, John D., “Project Financing: Asset-Based Financial Engineering” (Second Edition): John Wiley & Sons, Inc. Hoboken, NY.

Photo Source: www.enron.com, www.ge.com, www.cia.gov

Georgia: AES AES Corporation's 1998 purchase of Telasi,

Georgia's electricity-distribution company.– The venture resulted in one catastrophe that could not

have been anticipated: The murder of AES-Telasi's CFO, Niko Lominadze, in 2002.

– Although the police officer (whose gun was identified as the murder weapon) was arrested, he was released a few months later.

Source: “How to Bungle Political Risks: A survey finds that most senior executives consider overseas perils a low priority, even when they have investments and operations abroad.” Helen Shaw, CFO.comMay 24, 2006

Photo source: www.aes.com; www.cia.gov

Venezuela: Telecommunications Feb 2007 The Venezuelan government signed a

memorandum of understanding to purchase CANTV, the country’s largest telecommunications company.

– “…the negotiated cost satisfied Verizon and the Venezuelan State”

– During ’06 Verizon entered into a definitive agreement to sell its indirect interest in CANTO to Telmex for $677 million…

after two prior extensions, the parties terminated the agreement… concluding that regulatory approvals would not be granted by the

Venezuelan government… in Jan ’07 the Venezuelan government declared its intent to

nationalize CANTV at a price of $572 million…

Source: Venezuelanalysis.com “Venezuelan Government and Verizon Agree to Telecom Nationalization”Verizon 2006, 10-K, dated Feb. 23, 2007

Venezuela: Electric Company Feb 2007 – Venezuela nationalized EDC, Venezuela’s

largest electric company.– AES President Hanrahan stated “I think the deal is a fair one”– In connection with the agreement, management concluded that

a material impairment of the investment has occurred… Management estimates this impairment charge to be in the range of $550 to $650 million

SEC FORM 8-K filed, Feb. 27, 2007Source: Venezuelanalysis.com “Venezuela and Electric Company Sign Memorandum for Nationalization”

Venezuela Oil April 2007 - Major international oil companies, agreed

Wednesday to grant the Venezuelan government majority control over four multibillion-dollar heavy-oil projects in the vast Orinoco reserve.

– "We're optimistic that on these conversions of the heavy oil projects there's an opportunity for the companies to come out OK," said Peter Sommer, Chevron's commercial manager for Latin American exploration and production.

Source: Boston.com “Chevron "optimistic" about Venezuelan takeover”

64

Source: New York Times, “How Bad Is Inflation in Zimbabwe?” by Michael Wines, May 2, 2006 Available at: http://www.nytimes.com/2006/05/02/world/africa/02zimbabwe.html?ex=1304222400&en=e4f95916b4e5d098&ei=5088

Hyperinflation: Zimbabwe

At a supermarket in Zimbabwe, toilet paper costs $417 Zimbabwean dollars.

– Not per roll. $417 is the value of a single two-ply sheet.

– A roll costs $145,750 (US$0.69). Toilet paper, bread, margarine, meat, and tea —

have become unimaginable luxuries. The government tripled the salaries of civil

servants The government admitted that it had printed at

least $21 trillion in local currency — and critics say much more — to buy the American dollars to pay IMF loans.

The rise of inflation was caused by a flight of foreign capital (after the government seized farmland), and a steep increase in the money supply - the fall was caused by a rise in interest rates and an economic slowdown.

Institutional Investor’s Country Risk Ratings [Latin America]

Country 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005Argentina 21.0 29.4 25.1 23.2 19.0 18.3 20.2 26.2 33.8 37.8 38.8 38.9 41.3 41.8 42.4 45.8 34.7 23.8 14.5 22.2 26.4Belize 35.2 38.8 35.1 31.4Bolivia 7.5 8.0 8.1 9.7 9.0 13.2 15.0 17.0 18.7 21.4 22.4 25.4 26.2 27.0 28.4 28.6 30.8 28.8 30.7 27.4 29.9Brazil 30.9 35.2 31.7 28.4 27.8 26.5 26.5 27.1 27.8 30.3 34.9 38.3 39.5 38.1 36.5 45.0 42.1 40.2 36.1 42.6 48.2Chile 23.3 25.1 26.3 28.9 33.6 37.8 41.1 45.9 51.5 54.9 57.4 61.2 63.5 62.0 61.0 67.2 64.2 64.0 64.7 67.5 71.6Colombia 38.6 39.2 39.2 37.9 36.9 33.7 36.6 37.2 40.4 44.4 46.5 46.7 47.2 46.2 44.1 44.0 38.8 39.4 37.5 43.3 46.2Costa Rica 14.2 17.0 17.0 17.9 18.4 21.1 22.5 23.8 26.8 30.3 31.0 33.9 36.0 36.4 40.5 47.5 44.1 44.5 44.0 50.1 50.1Cuba 13.6 14.2 13.5 13.4 10.7 10.5 8.9 7.8 7.7 8.4 8.7 10.8 11.3 12.5 12.1 14.1 13.7 13.3 13.7 18.5 17.0Ecuador 25.0 26.7 24.1 21.4 17.8 17.6 19.6 20.4 21.3 24.5 25.1 26.4 26.3 26.1 22.4 18.3 19.0 19.5 23.2 28.1 28.0El Salvador 6.1 7.4 8.1 9.2 9.8 10.9 11.0 11.7 15.3 18.7 20.1 21.6 27.5 28.7 35.6 46.3 41.9 43.5 41.5 46.8 47.6Guatemala 12.4 13.2 12.6 14.4 14.5 16.9 17.5 16.8 18.1 21.5 22.1 22.7 26.8 26.6 28.1 37.1 31.4 33.2 33.0 39.6 41.5Guyana 26.5 30.4Honduras 9.8 12.9 12.1 14.5 14.6 13.8 14.4 13.7 15.6 17.0 15.9 18.7 18.9 20.1 19.3 26.6 22.5 23.5 25.9 30.6 28.9Mexico 39.2 30.8 27.1 28.9 30.3 35.0 38.7 42.6 45.6 46.1 41.8 41.6 43.5 45.4 48.2 56.7 55.3 57.2 58.5 60.0 63.0Nicaragua 4.4 5.5 5.3 5.2 4.5 5.9 7.1 7.9 8.7 10.1 9.6 11.4 13.5 12.4 12.1 21.8 18.9 18.4 18.2 21.7 23.1Panama 31.1 31.0 29.9 24.8 18.0 18.0 17.1 18.2 20.9 24.4 26.4 28.5 33.6 38.1 41.7 46.7 46.4 46.0 44.7 49.9 50.1Paraguay 32.7 31.0 29.2 26.9 27.5 27.0 26.6 26.2 27.2 31.0 30.7 32.1 33.5 32.7 31.3 32.5 28.9 27.9 28.6 28.8 29.2Peru 18.2 14.9 13.5 12.9 10.2 11.1 12.2 13.3 15.0 21.0 25.8 30.0 33.7 34.6 37.0 42.3 34.7 37.1 36.3 44.5 45.5Uruguay 27.5 27.8 27.9 28.4 28.8 30.9 31.2 32.0 34.2 37.1 38.5 40.1 43.4 45.2 47.2 53.5 49.5 49.0 31.6 33.5 37.8Venezuela 37.3 38.1 36.1 36.0 32.1 32.2 37.1 39.0 37.6 36.0 31.4 32.0 35.4 36.1 33.8 37.9 33.3 34.4 29.6 32.9 38.8Average 21.8 22.6 21.5 21.2 20.2 21.1 22.4 23.7 25.9 28.6 29.3 31.1 33.4 33.9 34.5 39.6 36.1 35.7 34.3 37.5 39.2U.S. 96.1 95.1 92.5 89.7 90.3 88.8 88.0 87.1 89.2 90.8 90.7 90.7 92.1 91.2 90.9 90.9 91.6 92.5 93.3 93.7 92.5Global Average

40.3 40.5 39.3 38.7 39.0 39.0 37.9 35.9 36.1 37.5 38.5 39.6 41.1 41.2 41.5 43.4 41.5 41.2 42.1 42.7 44.1

Institutional Investor’s 1985-2005 Country Credit Ratings, Institutional Investor, various issues.

3. Risk & Capital Budgeting Two Methods to account for risky cash flows:1. Change the discount rate

– Example: Use 6% for investments in Great Britain, United States, &

Germany Use 15% for investments in Russia

– The higher the discount rate, the higher the projected net cash flows must be for an investment to have a positive NPV.

– Critics argue: 1) it penalizes early cash flows too much and 2) does not penalize distant cash flows enough.

2. Change the cash flows

Formula for NPV Net Present Value (NPV) is the sum of

discounted expected cash flows.

Example: expect $10 for 3 years at a 5% discount rate.

(1 )tCF

NPVr

1 2 3

10 10 10~ $27

(1 .05) (1 .05) (1 .05)NPV

Expected CF

(100) (80)(50)

(10)40 100 110 130 160 200

IRR = 20%NPV = 0

Increase the Discount Rate

(100) (80)(50)

(10)40 100 110 130 160 200

Discount Rate = 15%New NPV = 30

Discount Rate = 10%Positive NPV = 141

Reduce Future CFs

(100) (80)(50)

(10)40 100 110 130 130 130

Discount Rate = 10%New NPV = 102

“The goal of financial forecasting is to turn chaos into error.”

Elliott Smith, Boston College

Financing Decisions Source of Financing

– Global Capital Markets Typically have a lower cost of capital Host government-regulations

– Local debt financing Use local debt financing if the currency is expected to depreciate

(because if you have foreign debt, it will take more of the depreciated currency to repay your loans).

Financial Structure– Debt – Equity Ratios

Tax laws regarding dividends and interest Norms

– Average debt ratio in Singapore is 0.34– Average debt ratio in Italy is 0.76– Average debt ratio in US & UK is 0.55

Source: Multinational Business Finance, 11th Edition

Lower Interest Rate Domestic

If you lend 90% of $100

$

Available to

Lend

(90%)

Reserve Requirement (10%)

at 10%, you earn

$9.

Eurocurrency Market

If you lend 100% of $100

$

Available to

Lend

(100%)

at 9.5%, you earn

$9.50.

Zero Reserve Requirement

Money Management Efficiency Goals:

– Minimize Cash– Reduce Transaction Costs

Tax Considerations– Tax credits, tax treaties, etc.– Dividend Remittances– Royalty Payments & Fees– Transfer Prices

3 Foreign Exchange Risks Transaction exposure

– The extent to which income from individual transactions is affected by fluctuations in foreign exchange values.

Translation exposure– The extent to which the reported consolidated results and

balance sheets of a corporation are affected by fluctuations in foreign exchange values.

Economic exposure– The extent to which a firm’s international earning power is

affected by changes in interest rates.

Tax Treaties: Japan/Germany/U.S.Exhibit 21.1: Comparison of Corporate Tax Rates for Japan, Germany, and the United States

Taxable income category Japan Germany U.S.Corporate income tax rates:

Profits distributed to stockholders 30.0% 30.5% 35.0%Undistributed profits 30.0% 30,5% 35.0%Branches of foreign corporations 30.0% 30.5% 35.0%

Withholding taxes on dividends (portfolio):with Japan - 20.0% 10.0%with Germany 10.0% - 5.0%with U.S. 10.0% 15.0% -

Withholding taxes on dividends (substantial holdings):with Japan - 15.0% 15.0%with Germany 15.0% - 15.0%with U.S. 15.0% 5.0% -

Withholding taxes on interest:with Japan - 10.0% 10.0%with Germany 10.0% - 0.0%with U.S. 10.0% 0 to 25% -

Withholding taxes on royalties:with Japan - 10.0% 10.0%with Germany 10.0% - 0.0%with U.S. 10.0% 0.0% -

Sources & Notes: Multinational Business Finance, 11th edition, Chapter 21PricewaterhouseCoopers, Corporate Taxes 2003-2004"Substantial holdings" U.S. - applies to intercompany dividend payments; Germany & Japan -applies to shareholders with greater than 25% interest.

International Offshore Financial Centers

Transfer Pricing Today a product may be designed in one

country, some of the components manufactured in another country, other components manufactured in a third country, all assembled in a fourth country, and sold worldwide.

The volume of intrafirm transactions is high.

Transfer Pricing Example

German subsidiary

U.S. Parent Company

Component Source:Australian subsidiary

Ships Parts

Price paid to Australian SBU: $10Additional Cost to Produce: $10Sale price: $23Profit: $3

Cost to produce: $8Sale Price: $10Profit: $2

Ships Product

Example:A U.S. parent company sellsStuffed Bears.Parts are made at an Australian subsidiary,assembled in a Germansubsidiary and sold in the U.S.

Price paid to German SBU: $23Sale price: $25Profit: $2

80


German subsidiary

U.S. Parent Company


Ships Parts



Ships Product



Tax Rate 35% = Profit $1.30 Tax Rate 40% = Profit $1.80

Tax Rate 35% = Profit $1.30

Total Profit After Tax: $4.40

81


German subsidiary

U.S. Parent Company


Ships Parts



Ships Product



Tax Rate 35% = Profit $2.60 Tax Rate 40% = Profit $0.60

Tax Rate 35% = Profit $1.30

Total Profit After Tax: $4.50

Manipulating Transfer Prices Pros

– Minimizes tax liabilities– Hedges against foreign exchange risk– Circumvents government restrictions on capital flows– Reduce tariff payments

Cons– Distorts incentive systems– Ethical considerations– Regulation Scrutiny!

“International finance is the art of passing currency from hand to hand until it disappears”

Anonymous Author

Tomorrow “The Bottom Line” So… Why is Harvard Great? Final Exam Review

international business

Documents

host country operations3

home country skills

resource management

management training

financial management

positions belief

host countrycan lead

global headquarters