Running My Own Multinational Corporation - Research Paper Example

Running My Own Multinational Corporation Chapter Business Idea The business idea which will be focused upon for the purpose of setting up a multinational business corporation relates to the manufacturing and selling alcoholic beverages, which will be branded as “Seven Star Wine”. The company, which will be named as Oceana Beverages Incorporation, will be based in the United States and will operate as a multinational enterprise focusing on exporting its products to UK market only. The alcoholic beverages will be manufactured and packed in the United States and then distributed for local markets and exports to the UK. For selling the product in the UK market, the company will enter into arrangements and agreements with the local retailers in the UK, particularly in the major cities. The retailers which will be considered for distribution and sales of the product will include Tesco PLC, Sainsbury’s PLC, Morrison’s PLC, ASDA PLC and other retailers. Keeping in view the fact that the consumption of alcoholic beverages in the UK and its supply has shown consistent growth, it can be therefore expected that the consumers in the UK will buy this product. As per the information provided by the World Health Organization, there has been a steady increase in the consumption of Beer during the past 45 years (45 years include years from 1961 to 2006). Source: (World Health Organization) In addition to this, since the company will enter into arrangements with local retailers and distributors in the UK for the sale of products, there will be no need to hire labor or acquire specific supplies for any other purpose. The company, Oceana Beverages Incorporation, will dispatch its products directly to retailers at specified city destinations. The retailers will then take charge of the good upon delivery and will be responsible for handling and selling the products through their respective retail outlets. As far as the manufacturing of the product is concerned, 100 percent manufacturing will be carried out within the United States at the production facility of Oceana Beverages Incorporation. In addition, packaging for both local and export deliveries will also be done by the packaging unit of the company. In this way, all expenses related to the production of Seven Star Wine will be incurred in US Dollar only. Chapter 2 Assessing Country Factors that will affect the Demand for the Product There are numerous factors which may have an impact on the balance of trade between the United States and the United Kingdom. These factors, in relation to the business of Oceana Beverages Incorporation, mainly include the cost of production in the US as compared to UK, costs associated with raw materials and other necessary inputs required for production, changes in the exchange rates between the two countries, bilateral agreements on trade, tariffs, etc., trade barriers which are other than tariffs and comparative price of wine available in the UK as compared to the price of wine sold by Oceana Beverages Incorporation. If the cost of production and cost of raw materials is higher in the US as compared to the UK, the price of the product will also be higher when placed in the UK market, which will deter consumers to demand it. Moreover, if pound sterling is strong against the US dollar then it will be favorable for consumers in the UK to demand and consume products which are imported from the US. Similarly, trade barriers including tariffs and other charges will add to the cost of the product and therefore consumers will be charged higher prices, which will result into lower demand for the product (Brigham and Gapenski). In case of Seven Star Wine, exchange rate changes and tariffs and duties in the UK for imported goods are the biggest factors which may influence the demand for the product, as these factors result in raising the price of wine and rendering it less competitive as against the local manufacturers. Accessing Trade Data As per the figure provided for the year 2012, UK remained the largest importer of wine in the world. By the end of the year 2012, total wine imported by UK amounted to € 3,944 million (Karlsson). Accessing Import Controls There are certain regulations being established by the government of UK for wine imports. These regulations include standards pertaining to the quality of the product, obtaining license for trading wine and labelling. In addition to these regulations, the EU’s regulatory framework for trading wine is also applicable in the UK to a certain extent (GOV.UK). Chapter 3 Using the Foreign Exchange Market The spot market allows settlement of payments or conversions immediately. It implies that any funds received from the export business by the company can be converted from British Pound into US Dollars on the same day rate. However, the settlement period for foreign currency contracts is two days, which means that the deal will be settled on the second day of deciding the settlement rate. This can be used by the company for converting its export payments received from distributors and retailers in the UK (Kevin). In order to receive payment from importers, Bank of America Merill Lynch will be used. The bid and ask spread on GBP/$ is 1.6618-1.6611 = 0.0007. The company can also allow credit facility of its distributors, which can make the payment for their import in any time period agreed with the company. In this situation, the company may need the forward market to book forward rates for conversion of inward export remittance at a future date. The forward rates for export payments are quoted at a discount, which implies that they are at lower level than the sport rate. This fixes the amount that the exporter will receive for foreign currency payments received at a future date. This protects the business from any unfavorable movement in the currency exchange rate (Kevin). Accessing Bid/Ask Rates The prevailing (12 March, 2014) bid and ask rates for UK pound are as follows: Bid Rate Ask Rate 1.6618 1.6620 Source: (Yahoo Finance) Accessing Recent Exchange Rates The changes in the exchange rate for GBP/USD in the past three months and in the last year indicate an increase in the same. Following are the charts which show 3 monthly and yearly changes in the exchange rate between GBP and USD: Source: (Yahoo Finance) Source: (Yahoo Finance) Chapter 4 Monitoring Movements in the Foreign Currencys Value Movements in the foreign currency’s value are initiated due to various factors, which are related to two countries for which foreign exchange rate is being considered. Among these factors, the major factors include the differences in the interest rates prevailing in the two countries, differences in the inflation rates, current account deficit, the amount of public debt, terms and conditions of trade between the two countries and the political and economic outlook of the countries (Madura; Kevin). Chapter 5 Using Currency Futures and Options Oceana Beverages Incorporation can use futures contract to hedge against the exchange rate risk related to pound sterling. In such a scenario, the company can make arrangements to buy dollars against pounds at a future date at a particular rate, thus avoiding the risk of fluctuation in the exchange rate (Brigham and Gapenski). On the other hand, the company can also use options contract to purchase dollars against pounds in a future time period at a specified rate, which would also mitigate the risk associated with fluctuations in the exchange rate (Brigham and Gapenski). Chapter 6 Monitoring Central Bank Intervention The central bank of every country aims at controlling the value of its domestic currency, while taking into consideration many factors, including the foreign exchange market trends. Likewise, the central bank of the United States of America, the Federal Reserve, is charged with the responsibility of maintaining US Dollar’s value against other currencies in the international market. In doing so, if the Federal Reserve goes for strengthening of dollar against other foreign currencies, it would imply that the bank will exchange other currencies for home currency, which will in turn increase dollar’s value in the international market. In such a scenario, Oceana Beverages Incorporation will be able to report lower revenues and profits, due to decline in the value obtained after translating a weak GBP against US Dollar (Kevin). On the other hand, if the Federal Reserve opts for weakening of dollar against foreign currencies, it will pose a favorable impact on the revenues of Oceana Beverages Incorporation from its UK sales, as GBP upon translation in US Dollar will increase the total revenues in dollars in the consolidated financial statements of the company (Kevin). Besides these measures from Federal Reserve, some indirect interventions, such as managing interest rate, inflation rate, government control or expectations of changes in the exchange rates of dollar in future, may also influence the business of Oceana Beverages Incorporation (Kevin). Accessing Central Bank Information The central bank of the UK, which is the Bank of England, operates through various policy tools to control its currency in the foreign markets. These include monetary policy tools and direct and indirect interventions in the market for adjusting the value of its currency in the local and international market. Chapter 7 Assessing Spot and Forward Rates The bid rate for export payment quoted by Bank of America Merill Lynch is GBP1:$1.6611. On the other hand, the bid rate quoted by Export-Import Bank is GBP1:$11.6612. This shows that the spot rates are aligned by they do tend to differ between banks. This could be due to their business approach and focus or difference in timings between quotes obtained from both banks. The one-year forward rate is 1.6611 – 0.0044 = 1.6567. The difference between the spot rate and the forward rate is based on the interest rate differential that may exist in countries of currencies considered. The findings indicate that the interest rate in the US are higher than the UK which suggest that interest rate parity exists. From the information examined for forward rates it can be noted that the foreign currency exhibits a premium. In this case, risk free interest rate set out the FED is 0.75% and the Bank of England has set it at 0.50%. This shows that there is interest rate parity as investors in the UK have the choice of converting their currency in US dollar and invest in risk free security of the US to generate higher return. This clearly indicates that the foreign currency exhibits a discount as the interest rate in the US are higher than in the UK. Chapter 8 Determining Whether IFE Holds Following are the quarterly interest rates for the UK and the US and the corresponding difference in the two: Quarter UK Interest Rate US Interest Rate Difference Dec-12 0.5 0.25 0.25 Mar-13 0.5 0.25 0.25 Jun-13 0.5 0.25 0.25 Sep-13 0.5 0.25 0.25 Dec-13 0.5 0.25 0.25 Source: (Trading Economics; Trading Economics) On the other hand, for the above mentioned quarters, following are the percentage changes noted in the exchange rate for GBP/USD: Percentage Change in Exchange Rate Dec-12 0.59% Mar-13 -6.48% Jun-13 0.03% Sep-13 6.38% Dec-13 2.43% Source: (X-Rates) Keeping in view the difference in interest rates for the two countries and the change in exchange rates, it can be stated that the International Fisher Effect does not hold in the given case. Chapter 9 Monitoring Exchange Rate Trends The weekly changes noted in exchange rate for pound sterling against US dollar for the past five weeks are presented as follows: Date Week GBP to USD (Exchange Rate) Friday, February 7, 2014 1 1.639107 Friday, February 14, 2014 2 1.673653 Friday, February 21, 2014 3 1.662619 Friday, February 28, 2014 4 1.674744 Friday, March 7, 2014 5 1.672308 Source: (X-Rates) The trends noted in the past five weeks have been plotted on a graph as follows, which shows abrupt changes in the exchange rates for pound sterling against US dollar. Keeping in view the above presented weekly exchange rates for pound sterling to US dollar, following is the percentage change noted in the exchange rate for the selected weeks: Percentage Change Week 1 - 0.358 % Week 2 2.108 % Week 3 - 0.659 % Week 4 0.729 % Week 5 - 0.145 % Based on the percentage change determined above for each week, the average percentage change has been determined as 0.335 percent. This implies that on weekly basis there is an average increase in the exchange rate for pound sterling against US dollar. Chapter 10 Recognizing Exposure to Exchange Rate Risk Owing to the fact that the company will also operate in a foreign country, i.e. the UK, therefore the company will face transaction and economic exposures due to fluctuations in the exchange rate between US Dollar and Pound Sterling. As for instance, there may be changes in the exchange rate between the home currency and currency in the foreign country, which may positively or negatively influence the overall financial picture of the business (Brigham and Gapenski). Apart from this, there is a possibility that the business will face all three risks associated with exchange rate fluctuations, which include transaction, translation and economic exposure risks. As for instance, in short run, fluctuations in exchange rates may impact the obligations of the company in the UK and thereby give rise to transaction exposure. Similarly, changes in exchange rates may influence the translation of earnings in foreign currency into US Dollar and thereby have an unfavorable impact on the consolidated financial statements. Lastly, the market value and future cash flows may be negatively affected by economic exposure due to changes in the exchange rates in future which are contrary to the forecasted or expected changes, which in turn affects the overall competitiveness of the company in foreign market (Clark and Marois). Chapter 11 Hedging with Forward Contracts Keeping in view the exposure to fluctuation in exchange rates for pound sterling, the company can consider hedging by using forward contracts. Through forward contracts the company can eliminate the risks related to exposure to fluctuation in exchange rate for pound sterling in future. In this regard, Oceana Beverages Incorporation can lock a particular dollar-sterling exchange rate for future and thereby translate its transactions in sterling into dollar on that particular rate. On the other hand, options can also be used to mitigate the exposure risk. In this case, the company can set a rate at which it can translate its transactions in sterling in future, or it may choose the current exchange rate between dollar and sterling if it is more feasible (Clark and Marois). Chapter 12 Denominating Receivables in U.S. Dollars The denomination of receivables in US Dollars will reduce the risk for the company in relation to losses reported on the consolidated financial statements due to transaction exposure. Moreover, in the long run, risks associated with economic exposure can also be mitigated since the company can make adjustments for weakening dollar against pound sterling and therefore no negative impact on its sales and corresponding revenues and profits will be reflected in its financial statements in the long run (Clark and Marois). Chapter 13 Establishing a Subsidiary in the UK The foremost benefit of establishing a subsidiary in the UK rather than carrying on with exporting the wine from US is that there is a comparatively stable inflationary trend in the UK. This stability in the inflation rates in UK will influence the cost of production over time as minimum variations can be expected in the budgeted costs to manufacture products in the UK. On the other hand, another benefit which Oceana Beverages Incorporation can attain through establishing is its expansion. Upon establishment of the subsidiary, the company will be required to provide initial equity capital to the subsidiary, which can be increased by allowing subsidiary to retain some portion of the profits earned and remitted to Oceana Beverage Incorporation back in the US. In addition, the parent company can avoid exposure to abrupt changes in the foreign exchange rates, reduce foreign currency translation costs and other related expenses (Kevin). However, there are some reasons which may render the idea of establishing subsidiary in the UK. First of all, it is difficult to estimate that the cost of manufacturing in UK will be lower, higher or equal to the cost which will be incurred in the US. In addition, the parent company may not be able to control the operations of its subsidiary in the UK. Chapter 14 Deriving a Required Rate of Return for an International Project Based on the estimated growth in the companys export business, a project of expanding its current production can be considered by the companys management. For this purpose, the company will estimate the initial investment requirement for buying new machinery and altering processes to ensure that the production can be supplemented. The company has a choice of raising capital for this project from internal and external both short and long-term finance sources. However, considering the nature of the project long-term finance options are considered appropriate. The company will incur cost of capital, which can be calculated as Weighted Average Cost of Capital (WACC). Since, the company will raise this funding denominated in US Dollars therefore there is no factor of currency risk to be incorporated in WACC (Brigham and Gapenski). The WACC can be calculated using the following formula: WACC = (E / (D + E) x K e + (D / (D + E)) x K d x (1 - Tax Rate) E = Total Equity D = Total Debt K e = Cost of Equity (which can calculated using CAPM Model) K d = Cost of Debt (cost of borrowing of the company) Tax Rate = Tax applicable to the company The required rate of the project will be higher than the WACC which will cover its costs for the project i.e. R * > WACC (Brigham and Gapenski). Chapter 15 Estimating Cash Flows of an International Project Since the company is established in the United States and its revenues generated in the UK will be translated into dollar amounts, therefore the company will use prevailing spot rates to predict annual revenues, expenses and net cash flows. However, there are certain limitations using this approach, which are due to the fact that exchange rates may change in the future and therefore revenues, expenses and cash flows may be affected significantly. For this purpose, the company will consider historical annual rate changes and thereby develop an interval in which fluctuations in future rates can be expected. However, having done so, there is still a risk that the cash flows expected may be overstated due to overstatement of the exchange rate based on assumptions developed through the analysis historical trends (Kevin). Chapter 16 Assessing Exposure to Country Risk To ensure effective financial mechanism organization is required to carefully identify the financial factors that may lead the business at risks, such as, exchange rates, industry structure, competitiveness and economic volition (Choi and Powers). Some of these can be overcome through insurance, hedging and financial planning. For a trading organization the risk of foreign exchange rate is a paramount consideration, and change in the exchange rate can greatly influence the profit volumes of the organization (Giles). The industrial risks, that is the competiveness, potential of substitutes, new entrants and capabilities of consumers and suppliers can influence operations of the organization (Rose and Spedding). For an international trading organization it is essential to determine the political factors of the home and traded country (Clark and Marois). This is because of the reason that the government intervention in the country on the regulation, taxation policies, trader barriers and foreign investment restriction in the country can be a major obstacle for effective functioning of the organization. Every country follows particular economic goals through extensive tariff and non-tariff barriers. As the organization operations are based on the exports, it is essential to determine the political, international and economic factors of the country to prevent risks (Clark and Marois). Chapter 17 Capital Structure Decisions Capital structures are referred to as how a company finances its operations in order to maintain consistency and avoid maximum risks. A company can obtain long term or short term financing in the form of equity, debt or a combination of both. Therefore it might be said that capital structure is the proportion of debt and preferences and equity shares on a company’s balance sheet. In the given scenario it would be appropriate for the company to adopt the capital structure based on equity proportions because the business that is being conducted comes under the heading of small or medium scale business and by its type is a business of trading. Therefore it can be easily determined that a heavy amount of investment is not required for the company to operate. Another reasoning to adopt such a capital structure is because this is the most common type of way for financing a company’s operations with minimum weighted average cost of capital which results to minimal risk for a company’s value. Chapter 18 Long-Term Debt-Denomination Decision The interest rates for the past eight quarters show that for UK, interest rate has remained at 0.5 percent, whereas US has maintained an interest rate of 0.25 percent. It is feasible to borrow long term funds in the currency denominated under the foreign currency of concern as it enables lowering down the risk associated with exchange rate exposure. As for instance, it becomes possible to forecast the exchange rate changes for the period in which amount borrowed and financing costs have to be paid. Chapter 19 Ensuring Payment for Exports There are some measures which are required to be taken in order to help minimize the risks which are connected to, when trading in overseas markets. It is essential to find out as much as possible about the markets which are required to be targeted for sales and the circle of the product in the specified market. In addition to this the customer’s potential on the matter credit worthiness should also be sighted in a clear and detailed manner. Working with partners in the form of agents or distributors also helps in reducing the risk of payment turbulences (Madura). It would also be feasible to get an insurance cover for the exports. As in this type of business which is specifically an exporting business managed credit insurance scheme would be the most appropriate one because the entire business turnover depends on the exporting cycle and payments (Brigham and Gapenski). Chapter 20 Financing in Foreign Currency The exposure in the foreign currency can be offset by obtaining finance in the same currency, as it will allow the changes to in the currency exchange rates to be set off due to changes in receivables and payables (Brigham and Gapenski). As for instance, if the company plans to establish its subsidiary in the UK, it can obtain finance denominated in pound sterling. Any increase in the exchange rate for pound sterling against US dollar which would increase financing costs will be offset by the equal increase in the receivables of the company (Kevin). Chapter 21 Managing Cash For an international firm, it is essential to forecast the value of the United Kingdom’s currency with respect to United States Dollar. Any change in the currency has aggregate impacts on the development of the all forecast of the company. It is required to estimate collection receipts, the amount of the receipt and monthly portion of the receipts and an overview on the historical ash flow shall also be made. Then the treasurer should analyze the disbursements, the forecasting of disbursement provides understanding about the expenditures and prior payroll of the company. It allows firm to determine prominent payroll and debts. Before making the investment the treasurer should carefully identify the amount of the cash that shall be received monthly, subtract the amount that will be required for the monthly warrants. It can determine the amount of the cash that is available to invest and the cash flow budget can provide understanding about the length of time the amount can remain invested (Kevin). Works Cited Brigham, E and L Gapenski. Financial Management. Dallas: The Dryden Press, 1996. Choi, Jongmoo Jay and Michael R. Powers. Global Risk Management: Financial, Operational, and Insurance Strategies. NY: Emerland Group, 2002. Clark, Ephraim and Bernard. Marois. Managing risk in international business: techniques and applications. Ny: International Thomson Business, 1996. Giles, Steve. Managing Fraud Risk: A Practical Guide for Directors and Managers. Chichester: John wiley, 2012. GOV.UK. "Wine Trade Regulations." 2014. 12 March 2014. . Karlsson, Per. "Global wine exports and wine imports." 26 June 2013. 12 March 2014. . Kevin, S. Fundamentals Of International Financial Management. New Delhi: PHI Learning Private Limited, 2009. Madura, Jeff. International Financial Management. 10th. Mason: Cengage Learning, 2009. Rose, Adam and Linda S. Spedding. Business Risk Management Handbook: A Sustainable Approach. NY: Elsevier, 2008. Trading Economics. United Kingdom Interest Rates. 2014a. 12 March 2014. . —. United States Interest Rate. 2014b. 12 March 2014. . World Health Organization. "Global Alcohol Report." 2011. 9 March 2014. . X-Rates. "HISTORIC LOOKUP." 2014. 10 March 2014. . Yahoo Finance. "GBP/USD (GBPUSD=X)." 2014a. 12 March 2014. . —. "GBP/USD (GBPUSD=X)." 2014b. 12 March 2014. . —. "GBP/USD (GBPUSD=X)." 2014c. 12 March 2014. . Read More