Financial and Non-Financial Factors in International Business - Essay Example

? Answer a) Report i. Financial and non-financial factors to consider include; IBF Plc is a well established company in its local markets in the manufacturing and sales of office supplies. The company has a strong distribution strategy that has been enhanced by the existence of the e business ordering and supplies of the office supplies. This has made its clients develop a strong customer confidence on the firm solely because of its timely delivery of products (Madura 1999). The companies of such calibers are also not so much meaning that the market for office supplies is still green even in the foreign markets. It is obvious that each time a business is considering going abroad in its operations, there are likely risks that it is to face. These may be in regards to dealing with the local culture of the new market, the language, business practices and the regulations by the foreign governments (Tolentino 2000). A business has to therefore critically consider these factors before deciding on whether or not to venture on its operations abroad. Legal requirements; this has to be considered to help ensure that the business will oblige to the rules and regulations that support business in the new country (Eitemann, Stonehill & Moffett 1998). Lack of adherence to such rules and regulations normally cause conflicts and business problems in the process of trying to acquire new licenses or permits to commence operations. In most of the developing countries, the procedures or the rules are normally unnecessarily long due to the bureaucracies governing business procedures in those countries (Tolentino 2000). Therefore IBF must expect uphill tasks in obtaining such licenses in both majorities of the Asian and African states. The procedure of venturing into East Europe would not be quite hard since their regulatory procedures are quite easier. IBF should therefore get a way of accessing the legal procedures of the countries they want to exploit in each of the regions identified to avoid the possibility of paying huge fines and penalties for breach of laws. Thorough research on both business and accounting requirements and this will take place by hiring foreign accountant and legal attorney from those countries (Madura 1999). IBF should also consider the language in such a country since language barrier has in the past proved to be the greatest hindrance to business operations. The ease of understanding the official language should therefore be well known in advance. This owes to the fact that language is very important hence the business must consider the possibility and the cost of hiring a translator in case they have to invest in a country where a language they don’t speak is spoken (Eitemann, Stonehill & Moffett 1998). The other factor is the cross cultural issues; these issues are to a large extent likely to affect business operations depending on the products. This will also dictate the manner in which business operations will be effected since it is not always automatic that business operations take the same direction in different operation environments. Cultural differences may influence the way business associates interact and hence influence the attitude (Tolentino 2000). The business intending to expand its operations abroad should also consider the risks both business and financial that they are likely to face in the foreign markets. This is done through thorough market analysis to weigh the risk exposures and the returns. This will inform on the decision of the prospects to undertake such ventures or drop them. Is risks become more than the expected returns then the business is not profitable and is as good as not undertaken. Political factors are also necessary since businesses are only able to thrive in peaceful environments. Countries facing political instabilities are not good for business hence should be avoided by IBF due to the high political risks that they are likely to face. Therefore before a business ventures its operations in another country, they must ensure they critically look at these factors keenly (Solnik 2000). ii. Potential risks and strategies to mitigate them It would be advisable for IBF to invest abroad for the sake of diversifying its business operations and increasing the total return of the portfolio. In spite the fact that the benefits of investing abroad are farfetched most investors or all before they do so are normally hesitant due to the likelihood of the enormous risks that they are likely to face (Madura 1999). The risk that IBF could face can be broadly classified into three main categories; Transactional risks, currency risks and liquidity risks. Transactional risks; these appear to be the biggest barriers to investing in the foreign markets despite the fact that we live in a global and interconnected world. These costs still vary greatly depending on which foreign market one is investing in or intends to invest in. brokerage costs are high in the foreign markets as compared to the local markets and still there are other transaction costs like those for stamp duty, taxes, clearance fee and the exchange fees (Solnik 2000). The business must therefore consider this risk keenly and ensure they are highly minimized. The second risk that could affect the operations of IBF is the currency risk which is open due to the currency volatility. This risk happens because when a business has to invest in another country their currency will have to be exchanged into the currency of the country they are investing in at the current exchange rates. At the point of exchange the rates might be against the investor who in this case is IBF Inc. if the company intends to invest in Asia, Africa or East Europe, and then they have to protect their currency through hedging it against currency exposures. The other risk is the liquidity risk; this is also an inherent risk in the foreign markets. This is the risk of not being able to sell your stock quickly in the event a sales order is made. Liquidity risk is hard to dodge since it happens as a result of the conditions created by the markets (Baker 1988). The three forms of risks if not well handled can cause terrible loose to a business trying to venture its operations abroad (Daniels & Radebaugh 1997). Therefore IBF must work on ways to minimize these risks in case they decide to implement the strategies of venturing into operations abroad. The strategies depending on the risks will be as follows; the best way to minimize transaction risks is to purchase the foreign stock through the use American Depository Receipts since they are bought at the same costs as the stocks listed on the US exchanges. Currency risks on the other hand can be mitigated in a number of ways but the most obvious one being hedging of the currency involved (Connolly 2007). IBF must therefore look for the best way to hedge against a currency loss which will depend on whether they prefer using currency futures, options or forwards. For a local investors these tools may be complex hence the need for a financial specialist. As has already been mentioned, mitigating liquidity risks may be quite of a challenge and must be considered keenly. The surest way is to avoid investments that are likely to be illiquid over time. The investor must also conduct and evaluation of assets before purchasing them to determine if they are likely to be illiquid and one way is through the bid-ask price strategy. The spread of illiquid assets will be wide and should be avoided (Walter & Smith 1999). iii. Other strategies for entering the foreign market are; Apart from creating subsidiaries IBF can also use other ways to enter the foreign market which include; assembling, contract manufacturing, licensing, joint ventures and direct investments. Under assembling, IBF will compromise between exporting and manufacturing abroad. The firm will therefore produce all the products in London and ship the manufactured components of the product to be brought together in their final destination. By doing this the firm will save on the transport costs and the custom tariffs since such costs are normally lower on unassembled goods (Connolly 2007). The firm can also do what we call contract manufacturing where the office supplies will be produced in the foreign markets by local firms under contracts. This agreement only entails manufacturing hence other activities will be handled by the subsidiary firms at their own costs. This strategy saves the firm plant investment costs, transport costs and custom tariffs (Solnik 2000). Licensing is the next strategy; here the degree of risk of entry into the foreign market is limited as opposed to contract manufacturing. This strategy engages the licensee more in terms of time. An international licensing firm will give the licensee patent rights, trademark rights and copyrights or know how on products and processes. In return, the licensee will produce the instructed products, market them and pay the royalties. Joint venture is also another strategy which is quite common to the licensing (Walter & Smith 1999). The only difference is that the joint ventures give the international firm the right to have equity position and a management voice in the foreign firm. Lastly we have the direct investments where IBF will be required to establish a Greenfield manufacturing plant in the foreign market. This can be done through an acquisition or develop a new facility for production and distribution (Baker 1988). Answer 2 Joe is a UK company specialized in the production of chemicals some of which it exports. They do invoice in sterling pounds. Among the countries in the EU is UK that still uses the pound with the rest using the Euro? If the Euro strengthens, the sterling pound would weaken and if the Euro weakens the sterling pound becomes strong (Walter & Smith 1999). A weakened sterling pound will mean one needs more of the currency in exchange for the stronger one. The fluctuations in the foreign markets are never stopped. Joe Inc currency and the currency of the countries importing from them is different, in addition, the company may be in hold of payments and receipts that may take place in the future a situation which exposes the company to extreme adverse fluctuations and ultimate losses if not taken care of well (Daniels & Radebaugh 1997). The loss in case of Joe will come in the event that the sterling pound weakens against the dollar because the importers from Germany will have to pay less for the chemical imports they receive. This means IBF will receive less and hence if no loss is made then the company will make very little profits. On the other hand if the sterling pounds strengthen against the euro, out of the exports made to Germany, Joe Inc will receive more of the euro for the value of the goods exported (Levi 2000). The German corporations importing chemicals from Joe will be experiencing a weak state of their currencies. This will result into them paying more of their currencies against the goods given to them by Joe. These impacts will be experienced on the cash flows of the company and they will be short term in nature since they can be curbed through hedging. If the euro remains weak for a long time, this will mean that the sterling pound will be stronger for quite some time (Levi 2000). The supply of the Euro into the UK will increase drastically as the importers will be using more of their currency to get the required goods form the exporters (Baker 1988). This means that the UK goods like the chemicals from Joe Inc will exceedingly be expensive and this will make demand for goods in the UK to reduce while countries using the euro will want to sell to the UK since the low prices of their goods make them more attractive to the consumers in the UK. A reduction in the importation by UK will mean the consumers would now have less variety of goods and services most so those that UK does not produce. As a result the consumption bundle of the consumer will shrink meaning that the ultimate impact will be a reduction in the living standards of the UK citizens (Walter & Smith 1999). Answer 3 Part a The question as to whether capital budgeting of projects by multinationals should be done from the parent company perspective or subsidiary perspective is a subject of much debate. This is because the results of such budgeting would not be the same depending on the approach taken because the after tax cash inflows to the parent company will substantially differ and this difference is caused by; tax differentials, regulations which restricts remittances, the administrative charges and the exchange rates movements (Levi 2000). Therefore, from the parent’s company perspective it is appropriate to evaluate the projects given that the project can create a positive NPV for the parent and enhance the value of the firm. This is though only applicable in the case when the subsidiary is wholly owned by the parent (Baker 1988). Part b Apart from the above mentioned considerations for the capital budgeting for a multinational, there are a number of other factors to be considered before such budgets are done. One is the financing arrangement, this will incorporate the finance costs involved in the financing sources arrived at and these are captured at the discount rate (Shaprio 2008). This may at time be overlooked because most of the foreign projects are financed by foreign subsidiaries partially. Secondly, we have a consideration of the blocked funds; this is derived by the requirement of some countries that the earnings from such firms is reinvested locally for some specified period of time before remittances start to the parent company’s country. This is to ensure that both countries substantially gain out of such grand investments. Other factors include the uncertainty of the salvage value; this is because the salvage value of the project has a massive impact on the Net Present Value of the project and the MNC may want to calculate the break even salvage value of the other projects (Baker 1988). The uncertainty is therefore a significant factor to consider when it comes to such forms of projects. The impact of the project on the current cash flows should therefore be given due consideration since the new investment has the probability of wanting to compete with the existing business for the same customers due to the operations in the same environment. Lastly, the incentives by the host government should also be considered and rewarded accordingly (Taylor 1996). In this way the projects in the foreign country will be a success. Part c Multinationals normally have some characteristics which, lead to the increase in their cost of capital. This is because they operate in highly volatile and uncertain environments. The characteristics and how they affect the cost of capital will be as follows:- they have access to international capital markets hence they are able to obtain such funds at affordable costs as compared to how domestic firms would obtain them (Buckley 2000). In this context, the firm is able to get funds at uncertain costs depending on whether they are operating in the international markets, they are parent firms or they are subsidiaries. Subsidiaries are able to obtain such funds at lower costs hence lower cost of capital as compared to when it was the parent to obtain such funds (Shaprio 2008). Multinationals are able to diversify internationally by virtue of their operations. This is able to enable them reduce their cost of capital since it has sources of capital inflows from various parts of the world hence more stable. The international diversification whether by country or product helps lower the systematic risk hence lowering the beta coefficient resulting into lower cost of equity. Multinationals are also exposed to exchange rate risk and this has the possibility of rendering the firm bankrupt (Taylor 1996). This makes the shareholders demand for higher a return which translates into a higher cost of capital. Furthermore, they are exposed to country risks due to the additional cultural, political and financial risks. These all translate into volatility of returns which is detrimental to the cost of capital (Buckley 2000). Part d Among the two firms Pram plc is likely to enjoy the economies of scale since it will benefit from a variety of incentives from the countries it is building the plants in. this will reduce the costs of operations which will result into more returns. One, government attracting foreign direct investments normally do so by proving the companies with land and they also go ahead to subsidize on the taxes on materials (Taylor 1996). Land is a factor of production and if one gets it without charge then the returns are also wide. Secondly, depending on which country the firm is constructing the plants they will benefits from the cheap unskilled labor from the locals who need jobs hence will be able to produce cheaply. This means the firm establishing manufacturing plant will enjoy the economies of scales unlike the firm establishing distributorship since in the latter; they will have to incur all the operation costs as a company (Shaprio 2008). Part e Comparative advantage results when a country has the margin of superiority in the production of a good or provision of a service. Ricardo argued that countries will produce efficiently those products they are endowed with their resources. Comparative advantage assumes perfect occupational mobility of factors of production, they also assume constant returns to scale without the existence of externalities, and finally they ignore the transportation costs (Hall & Soskice 2001). Therefore comparative advantage is a dynamic concept and this is because depending on the existence of some factors, it can and actually does change over time. Therefore a given business can enjoy an advantage in the production of a product over time until such a time when fierce competitors come into the market. To remain relevant in the international markets, both the quantity and the quality of the factors of production have to remain outstanding (Hall & Soskice 2001). The country also has to invest in constant research and development and they also have to be observant on the movements of the exchange rates as this has the impact of going against the forms production through increased costs of production (Taylor 1996). In the modern business environment, comparative advantage is relevant since it allows businesses or countries to produce those goods that they are able to produce as they are endowed with the factors of production to such. They also propagate the need and importance of specialization a vital element in the modern business operations. When businesses are able to specialize they will be in the position of providing quality, quantity and within an efficient time. Most companies due to comparative advantage will be in the position of saving on the costs leading to the maximization of returns (Hall & Soskice 2001). References Buckley, A, 2000, Multinational Finance, Prentice Hall: Canada. Shaprio, A, 2008, Multinational Financial Management, 8th edn, Wiley & Sons: Canada. Solnik, B, 2000, International Investments. 4th edn, Addison-Wesley: Cheltenham, UK. Baker, J, 1988, International Finance, Prentice Hall: Cambridge, MA. Connolly, MB, 2007, International business finance, Routledge: New York. Daniels, J, & Radebaugh, L, 1997, International Business, 8th edn, Addison-Wesley: Cheltenham, UK. Eitemann, D, Stonehill, A, & Moffett, M, 1998, Multinational Business Finance, 8th edn, Addison-Wesley: Cheltenham, UK. Hall, PA, & Soskice, DW, 2001, Varieties of capitalism: the institutional foundations of comparative advantage, Oxford University Press: Oxford England. Levi, MD, 2000, International finance: the markets and financial management of multinational business (2nd ed.), McGraw-Hill: New York. Madura, J, 1999, International Financial Management, 6th edn, International Thomson: Chicago. Taylor, F, 1996, Mastering Derivatives Markets, FT –Pitman: New York. Tolentino, PE, 2000, Multinational corporations’ emergence and evolution, Routledge: London. Walter, I, & Smith, R, 1999, Global Capital Markets and Banking. 2ed, INSEAD, McGraw-Hill: Toronto. Read More