International Business Finance - Assignment Example

Word count: 2984 Course Work (Student Name) (Institutional Affiliation) BAAF Level H6 (Instructor) April 14, 2013 Question 1 A Evaluation of the financial and non-financial aspects to be looked into before completing the pitch to establish the subsidiaries in Africa, Asia and Eastern Europe: The decision making for establishment of subsidiaries is not hard when company applies only the financial knowledge. The conventional financial theories which the company could apply are the payback period, IRR and NPV techniques for the subsidiary investment decisions (Agrawal and Nagarajan, 2010). It is also possible to assess the investment’s risk by applying the probability analysis and sensitivity analysis. Nonetheless, the analysis based on cash pose certain drawbacks. According to (Eiteman, Stonehill and Moffett (2011) if knowledge regarding new investment are inadequate, if the operational projections are frail or if we assess the investment with a lot of uncertain and intangible factors (hard to measure), the risk and uncertainty augment, affecting the operational forecasts of the cash flow. The criterion of the discounted cash flow often undervalues the investment opportunities and frequently does not factor in any strategic as well as other operational variables, resulting to would-be competitive losses and myopic decisions. Investment decision could become more cumbersome to make if we factor in other components besides the financial aspects (Errunza and Senbet, 2009). So as to make the most appropriate investment decision, information would be needed concerning all aspects that can affect this decision. Thus, it is important to know how the non-financial factors could be used in the investment appraisal, appreciating that these may not be easily assessed in monetary aspects. The decision of investment would be established at the start of a project and relies on the final value being greater than the total investment. For our case, the appraisal techniques could be divided into two categories. On one side, the investment performance would be evaluated using the accounting data. Accounting profit and payback period rate would also be factored in within this category. Nonetheless, there evaluation techniques are not sufficient due to the problems related to accounting data. While on the other side, we should factor in cash flow methodology in investment appraisal. The decision of investment would therefore be based on IRR and NVP. Looking at risk assessment, we could get information regarding aspects that influence investments project. According to Kwok and Reeb (2009) the use of simulation analysis and profitability analysis methodologies would provide greater confidence levels for our final investment decision. Very often, the risk assessment incorporated in adjustments to the capital cost or discount rate or in the cash flow adjustments as well as the application of risk-free discounts. Most companies apply the similar discount rate in most or all of their investment projects. This clearly shows that firms pay little or no attention to investment assessment risk. However, we can adjust the discount rate depending on the type of the investment project based on the target market country (Lecraw, 2007). ii) The no-financial factors to be considered for the investment project Even though the financial aspect of investment decision is an important component of the investment decision course of action, the non-financial factors are also vital (Kumar and McLeod, 2008).The IBF Supplies Plc. Core non-financial elements would include: Good practise and matching the standards of the industry Fulfilling the requirements of the future and current legislations Enhancing staff morale, having efficient processes for retaining and recruiting employees Improving the reputation of the company as well as the relationship with the neighbouring community Enhancing relationship with the customers and the suppliers Developing the business capabilities, for example developing skills or improving the management systems Dealing with and anticipating unforeseen threats for instance, safeguarding the intellectual property from possible competition (Kogut and Singh, 2008) For instance, we would need to factor in the environmental effects of our investment project. To a certain degree, this could be reflected within the financial elements, such as energy or power savings that comes with new machinery. However, the other effects, for instance the effect of our reputation would also be critical. In some instances, non-financial methodology could be a significant requirement. For instance, we cannot invest on new machinery which contravenes safety and health regulations. QUESTION 1B: The potential risks and their management strategies According to Evrensel and Kutan (2007) risk management in foreign investment is vital within a growing globalized investment environment. IBF Supplies Plc would deploy risk mitigation strategies and polices to make sure that our interests are upheld when we engage in international investment operations. Some of the potential risks and their management strategies for IBF Supplies Plc may include the following: a) Supplier or customer reliability risk The global vendor or customer may an entity that is unknown, and it could be hard to authenticate their trustworthiness and credibility. Therefore, it could be a risky idea to cope with unproven global investment associates. The best way to manage this type of risk would be to only deal with internationally reputed or recognized foreign entities, and this must be our business policy (Johnson, 1997). The other way to manage this risk, it that prior to conduction any business dealing with unverified party, we must verify its credentials via the commercial departments of the local embassy based in that state, or via the chamber of commerce or through banks (Kaldor, 2005). b) The payment guarantee risk When IBF Supplies Plc requires to import particular goods from a international supplier, any form of payments to be made in advance prior to the consignment delivery would be risky. This could be specifically correct if the business would be dealing with foreign entities, which are not known. The most appropriate approach to manage this kind of risk would be to ensure that we employ the international Letter of Credit to be an instrument of payment, as opposed to transferring the money from the bank account (Johanson and Wiedersheim-Paul, 1995). This method works well because, we would be in a position to cash the payment, only when our business associates have actually delivered and produced the goods. c) Risk of the of quality and quantity of goods Notwithstanding the successful payment via the letter of credit, there is still risk of the actual material quality and quantity of the shipped consignment. To manage this risk, IBF Supplies Plc would appoint a globally reputed nonaligned inspection organization to assess the consignment, prior to its loading to the ship. The expenses incurred in this kind of inspection could be high, however these expenses shall the factored in within our pricing in advance (Jensen, 2006). This approach guarantees that the right quality and quantity of the goods are shipped from the international port. d) Country and customs risks George and Kabir (2005) observe that the social, economic and political conditions in Africa, Asia and Eastern Europe are viewed as external factors that we have no control over. This is an intrinsic risk in global investment that is inescapable. Nonetheless, a safe method would be to consider investments in those states that have good record of economic, social and political stability. The regulations and custom laws also vary from one state to the other. Hence, IBF Supplies Plc shall acquire adequate knowledge of the foreign nation’s domestic laws to make sure that we do not go against any law as a result of ignorance. e) Foreign Exchange Fluctuation Risks Currency fluctuations can be termed as a macro economic risk element which IBF Supplies Plc is not able to control. IBF Supplies Plc would try to deal with this risk through transacting only in globally stable currencies or we can opt to entirely transact only in the US dollars (Fisher, 2008). However, in instances where it is essential to operate in foreign currency, our transaction pricing would cover for any possible low margins that might result from inauspicious currency fluctuations. Once we have put these risk mitigations mechanisms, IBF Supplies Plc would hedge itself adequately against handling risks in global business. QUESTION 1 (iii) Possible strategies for Foreign Entry a) Licensing The first one would be through licensing. Licensing is an approach of foreign market entry with limited levels of risks. It is different from contract manufacturing because it is normally for loner duration and entails major responsibilities for the domestic producer. Licensing is more or less like franchising only that the franchising firm appears to be directly more engaged in the control and development of the marketing plan (Heyman, Deloof, and Ooghe, 2003). As the licensing organization, we would offer the licensee the trademark rights, the patent rights, know-how or copyrights of processes and products. In exchange of this, our licensee company will do the following: Manufacture our products They will market these goods within the territory where we shall assign to them These companies shall pay us royalties corresponding to the volume of goods sold. The only problem with this kind of foreign market entry us that issue of controlling the license because of lack of direct involvement from our side. In a couple of years, upon transferring the know-how, there is a potential risk that some of the foreign companies could start to act on their own and therefore IBF Supplies Plc may hence lose such a market. b) Though Joint Ventures The other market entry strategy could be through joint ventures which have quite similar to licensing in a number of aspects. The conspicuous different is that through joint ventures, we (IBF Supplies Plc) would have a management voice and equity position on the foreign company. We shall establish a partnership between IBF Supplies Plc and the foreign country company, which would result in the establishment of a third company. This form of market entry strategy would give us a good control over the business operations as well as the accessibility to the foreign market knowledge. We would to able to access to the franchisee’s relationship networks and we would be less exposed to expropriation risk which would be accredited to our partnership with the foreign company (Guedes and Opler, 1996).This mode of market entry is very common in global management. The popularity is achieved because it allows the control problem avoidance of other forms of international market entry modes. Moreover, the presence of that foreign company would enhance the integration of our company within the foreign setting. c) Direct Investments The other possible market entry strategy would be through direct investments. Through this arrangement, our company would make a direct investment and establish a production unit in those three target markets. We shall have 100% ownership, and hence we must gear up of a massive commitment. We can acquire the production facilities wholly in two fundamental ways: We could make a merger or a direct acquisition We can establish our own facilities from scratch In certain countries particularly in Africa, the government disallows 100% ownership by foreign companies and would demand for joint ventures or licensing which are still our options (Frank and Goyal, 2003). QUESTION 2 SOLUTION: When the euro strengthens, customers with the European market would still buy Joe’s products with fewer Euros. Because Joe’s competitors too invoice their export products in dollars, Joe’s firm would not acquire competitive edge. However, in general the demand for the goods might go up since the chemicals would be less costly to the customers in European market. When the euro weakens on the other hand, European clients would need to pay extra Euros to buy Joe’s products. And because Joe too exports his products in dollars, Joe’s firm might not essentially loss a portion of his market share. Nonetheless, the general demand in Europe for the chemical might reduce since the costs paid for the chemicals have gone up (Fan Titman and Twite, 2010). When the euro stayed weak for a number of years, there is a possibility that certain firms in Europe could start to manufacture these chemical in order for the clients to avoid buying dollars with euro that is weak. This implies that the U.S exporters might be out-priced from the European market as time goes by and the euro continues to weaken (Doukas and Pantzalis, 2011). QUESTION 3: Part A Solution: If a parent company allocates capital for an investment project, the parent ought to view the feasibility of the investment project from its perspective. It might be a possibility that the investment project may be feasible from the perspective of the subsidiary, but it might not be feasible when viewed from the perspective of the parent and this is as a result of exchange rate fluctuations or foreign withholding taxes which ultimately impacts on the money remitted to the parent company (Deesomsak, Paudyal, and Pescetto, 2010). Part B The additional factors which ought to be considered in international capital budgeting which might not be ordinarily applicable for a purely local project Some of the most apparent factors include: Whether there are currency restrictions in place The exchange rates The international demand for the goods produced The possibility of a foreign government takeover (Desai, Foley, and Hines, 2003). Part C Exploring how the features of MNC (Multinational Corporations) may influence the capital cost When evaluating options for funding a foreign investment, the multinational corporation has two matters to look at. The first concern is how to fund the international investment. It is even a greater concern when the MNC requires external funding, because the company has to make a decision whether to acquire the funds from foreign country sources or to acquire the financing elsewhere (Choi and Prasad, 2012). The next issue that has to be looked into is the financial structure configuration of the foreign affiliate. Cheng and Shiu (2007) point out that the capital cost is characteristically lower within the international capital market as opposed to most of the local markets. As such, other factors being constant, companies would opt to fund their investments by acquiring funds from the international capital market. The demands or regulations of the host government may restrict MNCs from borrowing from the international capital market (Cassar and Scott, 2011). In such a scenario, the discount rate applied in capital budgeting has to be reviewed upwards in order to reflect the situation. The MNC may decide to go for domestic debt funding for investments within states where the domestic currency is anticipated to devalue (Bhaumik and Gelb, 2009). Domestic financing can also enhance the subsidiary integration within the domestic business market offering additional business contacts as well as the protection from undesirable state actions (not ruling out expropriation, when at the extreme). According to (Bartov, Bodnar, and Kaul, 2011) there is an outstanding disparity between the financial structures of companies operating in various nations. This could be attributed to the disparities in cultural practices and tax regimes. In spite of the existence of these striking differences, the reasons for conforming to the domestic debt standards are not very strong. In general, the capital cost might be less for an MNC compared to a company that has no global operations because of particular features of the Multinational Corporations, for instance its access to the global capital markets, its sheer size, as well as its level of international diversification. On the flip side, the multinational corporation is faced with particular risks which may augment its capital costs, for example the exposure to the foreign country risk and the fluctuation of exchange rate (Barlett and Ghoshal, 2009). PART D As Barclay and Smith (2005) assert the external diseconomies and economies of scale are the costs and benefits linked to the expansion of the entire industry and the outcome from external elements upon which one company has no or little control over. Ram plc is likely to benefit from the economies of scale due to the positive externalities that it will enjoy once it has established the manufacturing units in different countries. For example, set has developed manufacturing units in other countries it will establish a network of transport of communication where all other market players will benefit from. The existing companies as well as specialist supplies can enter the industry and gain from its proximity. Ram plc would to able to access to the franchisee’s relationship networks and we would be less exposed to expropriation risk which would be accredited to our partnership with the foreign company. Part E According to Baker, Greenwood and Wurgler (2008) the hypothesis of comparative advantage asserts that a nation ought to specialize in the development of service or good over which it has less opportunity cost whereas it ought to import goods that their production have a greater opportunity cost. To comment of the usefulness of comparative advantage within the modern business setting the paper looks at the below issues. 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