Download I. What is the Goal of Management?

CHAPTER 17
FINANCIAL MANAGEMENT
Chapter Objectives
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To understand how value is measured and managed across the multiple units of the multinational firm
To understand how international business and investment activity alters and adds to the traditional financial
management activities of the firm
To understand the three primary currency exposures that confront the multinational firm
To examine how exchange rate changes alter the value of the firm, and how management can manage or
hedge these exposures
Opening Case
Summary:
When Schering-Plough had a downturn in business it elected to not repatriate cash reserves from overseas
to maintain its dividend level. Rather, it decided to lower its dividends significantly and to lay off at least
1,000 employees. It was not willing to pay the heavy taxes associated with bring the money back into the
U.S.
1.
Chapter Outline
I. WHAT IS THE GOAL OF MANAGEMENT?
A. Maximize stockholder wealth or consider financial and social health of all stakeholders?
Focus on Ethics
Stockholder Wealth Maximization and Corporate Culture: The Enron Debacle
Summary:
The conclusion of this case is that Enron’s culture focused solely on earnings-per-share growth and that this
focus on profits and greed led to many of the questionable ethical decisions and the demise of the company.
B. Global Financial Goals
1. Maximization of consolidated, after-tax income
2. Minimization of the firm’s effective global tax burden
3. Correct positioning of the firm’s income, cash flows, and available funds
C. Genus Corporation is a sample corporation used to illustrate how the various components of the
multinational firm fit together and how financial management must make decisions regarding
trade-offs
1. Tax Management would have Genus rearrange its profits into the countries having the
lowest tax rates
2. Currency Management would have Genus rearrange its profits into Germany because
of the stability of the euro
3. Funds Flow Management would have Genus rearrange its profits and cash flow to
minimize having funds blocked up in China
D. Multinational Management at Genus as an illustration of the complexity of the process
1. Financial management issues facing Genus
a. Primary goal is maximization of consolidated profits after tax
b. Consolidated currency is expressed in currency of the parent company, but may
reside in subsidiaries
c. Subsidiary financial statements are in local currency
Firm’s performance is on basis of Earnings per Share (EPS)=consolidated
profits after taxes divided by shares outstanding
e. Each subsidiary is subject to laws of the country where it is located
2. Financial decisions at Genus
a. Capital budgeting
b. Capital structure
c. Working capital
II. Import/Export Trade Financing
A. Trade Financing Using a Letter of Credit (L/C)—exporter collects money through his bank from
importer’s bank (Figure 17.2, page 567)
III. Multinational Investing
A. Capital Budget Components and Decision Criteria
1. Components
a. Initial Expenses and Capital Outlays
b. Operating Cash Flows
c. Terminal Cash Flows
2. Decision Criteria = Positive Net Present Value
B. A Proposed Project Evaluation Example is presented and the NPV is negative
C. Risks in International Investments
1. Different governments and laws
2. Different perspective of parent company (cash flows derived) and project (profitability
in local currency)
IV. International Cash Flow Management
A. Operating Cash Flows and Financing Cash Flows
1. Operating Cash Flows are from daily business activities and operations
2. Financing Cash Flows come from the funding activities of the firm (debt or equity)
B. Intrafirm Cash Flows and Transfer Prices
1. Transfer prices—selling products to own subsidiary
2. Repayments of loans from subsidiary who funded a project
d.
Focus on Politics
Swiss Unit Pays Penalty for Transfer Pricing Abuse
Summary:
This tells how a Swiss subsidiary tried to avoid taxes by paying inflated transfer prices to its parent
company in Japan. This lower net income for the subsidiary and that lowered taxes. The Japanese parent
ended up paying the taxes due plus a penalty.
C. Cash Management
1. Netting (Figure 17.4, page 575)—cash flows are two-way between units of
multinational firm and must be managed so that cash flows are netted against one
another with only on smaller cash flow occurring
2. Cash Pooling—use one pool of cash in one location managed to serve several units of
the multinational
3. Leads and Lags—timing of payments allows company to put cash where it is needed
most and manage currency risk
4. Reinvoicing—one center in a advantageous position takes ownership of goods going to
another subsidiary and creates a new invoice to take advantage of currency fluctuations
and taxes
5. Internal Banks—a “bank” owned by the company to buy and sell receivables from
units
V. Foreign Exchange Exposure
A. Transaction exposure—contractual payment of foreign currency
1. Cash flow is denominated in a foreign currency
2. The cash flow will occur at a future date
Focus on Culture
To Hedge or Not to Hedge?
Summary:
The story is told of how Coca-Cola’s profits are down due to losses it is taking by engaging in hedging to
protect itself against foreign currency fluctuations. Although in gained $87 million through hedging in
1999, it has lost money since then.
3.
Transaction Exposure Management
a. Natural hedging—arrange to have foreign currency cash flows coming in and
going out at roughly the same times and same amounts
b. Contractual hedging—using financial contracts to hedge the transaction
1) Forward contract—allows the firm to be assured a fixed rate of
exchange between the desired two currencies at the precise future date
2) A hedge—is an asset or position whose value moves in the equal but
opposite direction of the exposure
B. Economic exposure—long-term cash flows will be affected by unexpected future exchange rate
changes
C. Translation exposures—due to consolidation of financial statements
D. Risk Management versus Speculation
Focus on Ethics
The Role of Currency Gains in Amazon.com’s Quest for Profits
Summary:
Amazon.com was able to report it had met its goal of returning a profit at the end of 2001. However, it
turns out this profit was due to a one-time foreign currency gain of $16 million and not due to a sustainable
factor.
E. Transaction Exposure Case: Lufthansa
1. The exposure—Lufthansa agreed to pay Boeing $500 million a year later and if the
deutschemark continued to fall that would end up being more money to pay in one year
2. The management strategy—decided to use forward contracts to cover half the exposure
3. The outcome—since the dollar fell dramatically the company had to pay for the
forward contract
F. Currency Risk Sharing by importer and exporter to share risk
VI. Economic Exposure (Operating exposure)—change in value of a firm due to unexpected changes in
exchange rates
A. All firms have economic exposure
B. Impact of Economic Exposure varies
C. Economic Exposure Management—be prepared for the unexpected
1. Diversification of operations
2. Diversification of financing
VII. Countertrade—a sale that encompasses more than an exchange of goods, services, or ideas for money—the
linkage of goods or services instead of money (bartering)
Focus on Politics
The Booming Business of Countertrade
Summary:
This case tells how companies are using countertrade to dispose of goods on a more profitable basis than it
would by selling them. Several examples of company barters are provided.
1. How can a company that sells services get in on countertrade?
2. Can a small business do this also?
A. Benefits
1. Allows the circumvention of price controls
2. Due to preference of exchanging goods with major trading partners
3. Way to gain entry into new markets
4. Can provide stability for long-term sales
B. Disadvantages
1. May not be efficient—you have to want what the other party has
2. Accounts must be settled on a bilateral basis to maintain balance of trade