Working Capital Management for the Multinational CorporationInternational Financial Management

Dr. A. DeMaskey

Learning ObjectivesHow does multinational working capital management differ from domestic working capital management?What are the objectives of international cash management?What techniques are used by MNCs for making cross-border payments?What key factors are associated with a firms funding strategy?What short-term financing options are available?

Multinational Working Capital ManagementFunds AvailabilityAdditional RisksMovement of CapitalDecisionsTaxes

International Cash ManagementA set of activities, which consists of:Cash management - the levels of cash balances held throughout the MNC - Cash settlements and processing - the facilitation of its movement across borders

Cash ManagementCash levels are determined independently of working capital management decisionsCash balances, including marketable securities, are held partly for day-to-day transactions and to protect against unanticipated variations from budgeted cash flowsThese two motives are called the transaction motive and the precautionary motive.

International Cash ManagementGoal: Minimize cash balances without reducing operations or increasing risk.Steps:Cash Planning - anticipating cash flows over future days, weeks, or months.Cash Collection getting cash into the firm as soon as possible.Cash Mobilization moving cash within the firm to the location where needed.Cash Disbursements planning procedures for distributing cash.Covering Cash Shortages managing anticipated cash shortages by borrowing locally.Investing Surplus Cash managing anticipated cash surpluses by investing locally or controlling them centrally.

Cash Positioning DecisionCurrency of location Type of liquid asset held Maturities, yields, and liquidity characteristics

Objectives of an Effective Cash Management SystemMinimizing overall cash requirementsMinimizing currency exposure riskMinimizing political riskMinimizing transactions costsTaking full advantage of economies of scale

Complexities of the International Cash Positioning DecisionConflicting nature of cash management objectivesGovernment restrictionsMultiple taxation systemsMultiple currencies

International Cash Settlementsand ProcessingFour techniques for simplifying and lowering the cost of settling cash flows between related and unrelated firmsWire transfersCash poolingPayment nettingElectronic fund transfers

Wire TransfersVariety of methods but two most popular for cash settlements are CHIPS and SWIFTCHIPS is the Clearing House Interbank Payment System owned and operated by its member banksSWIFT is the Society for Worldwide Interbank Financial Telecommunications which also facilitates the wire transfer settlement processWhereas CHIPS actually clears transactions, SWIFT is purely a communications system

Cash Pooling and Centralized DepositoriesKey: Centralizing the cash positioning function to gain operational benefits.Subsidiaries hold minimum cash for their own transactions and no cash for precautionary purposesAll excess funds are remitted to a central cash depositoryCentralized depositories provide the following advantages:Information advantage is attained by central depository on currency movements and interest rate riskPrecautionary balance advantages as MNC can reduce pool without any loss in level of protection Interest rate advantages as funds can be borrowed at a lower cost and invested at a more advantageous rate.Location can provide tax benefits, access to international communications, clearly defined legal procedures.

Multilateral NettingNetting involves offsetting receivables against payables so that only the net amounts are transferred among affiliates.TypesBilateral nettingMultilateral nettingPayments netting is useful primarily when a large number of separate foreign exchange transactions occur between subsidiaries.

Payments NettingExample: A Belgian affiliate owes an Italian affiliate $5,000,000, while the Italian affiliate simultaneously owes the Belgian affiliate $3,000,000.Bilateral settlement calls for $2,000,000 payment from Belgium to Italy and cancellation of the remainder via offset.Multilateral netting is an extension of bilateral netting.Assume that payments are due between Apexs European operations each month. Without netting Apex de France would make three separate transactions each way.

Financing Working CapitalFinancing working capital requirements of a MNCs foreign affiliates poses a complex decision problem.Financing options for a subsidiary include:Intercompany loans from the parent or a sister affiliate.Local currency financing.

Key Factors Underlying the Funding StrategyInterest RateWithout forward contractsWith forward contractsExchange RiskDegree of Risk AversionTaxesPolitical Risk

Financing ObjectivesMinimize covered after-tax interest costsMinimize expects costsTrade-off between expected cost and reducing the degree of cash flow exposure

Intercompany LoansThe cost of an intercompany loan is determined by the following factors:Opportunity cost of fundsInterest rateTax rates and regulationsCurrency of denomination Expected exchange rate change

Local Currency FinancingBank LoansTerm LoansLine of CreditOverdraftRevolving Credit AgreementDiscountingCommercial Paper

Effective Interest Rate on Bank LoansSimple interest loanDiscount loanLoan with compensating balance requirementSimple interest loanDiscount loan

Effective Annual Percentage Cost IllustrationThe Olivera Corporation, a manufacturer of olive oil products, needs to acquire 1 million in funds today to expand a pimiento-stuffing facility. Banca di Roma has offered them a choice of an 11% loan payable at maturity or a 10% loan on a discount basis. Which loan should Olivera choose?

Calculating the Dollar Costs of Alternative Financing OptionsIn deciding on a particular financing option, a firm needs to estimate and then compare the effective after-tax dollar costs of local currency financing and dollar financing.In reality, the value of the currency borrowed will most likely change with respect to the borrowers local currency over time.Breakeven analysis can be used to determine the least expensive financing source for each future exchange rate.

Effective Financing Rate: No TaxesSuppose that Ford has an affiliate in Mexico, which can borrow pesos at 80% or dollars at 12% for one year.If the peso is expected to devalue from MP$ 7.50/$ at the beginning of the year to MP$ 10.23/$ at the end of the year, what is the expected before-tax dollar cost of the peso loan?What is the cost of the dollar loan to Ford?What is the breakeven rate of currency change at which the dollar cost of borrowing pesos is just equal to the cost of dollar financing?

Effective Financing Rate: No TaxesDollar cost of local currency (LC) loanrH (LC) = rL (1 + c) + c Cost of dollar loan (HC)rH (HC) = rH Breakeven rate of currency changerL (1 + c) + c = rH

Effective Financing Rate: With TaxesSuppose the Mexican corporate tax rate is 53%.What is the expected after-tax dollar cost of borrowing pesos?What is the expected after-tax cost of the dollar loan?What is the breakeven rate of currency change at which the after-tax dollar cost of local currency financing is just equal to the after-tax cost of dollar financing?

Effective Financing Rate: With TaxesAfter-tax dollar cost of borrowing local currency rH (LC) = rL (1 - Ta)(1 + c) + c After-tax cost of dollar loan rH (HC) = rH (1 - Ta) + cTa Breakeven rate of currency change rL(1 - Ta)(1 + c) + c = rH(1 - Ta) + cTa