Week 09 - Tutorial-Mishal Manzoor (Fins3616) - T3 2020

INTERNATIONAL
BUSINESS FINANCE
FINS3616
BY: MISHAL MANZOOR

m.manzoor@unsw.edu.au
Q1: Why do firms from each category below become multinational? Identify the
competitive advantages that a firm in each category must have to be a
successful multinational.
(A) Raw materials seekers

(B) Market seekers
(C) Cost minimizers
ANSWER:
Q1: Why do firms from each category below become multinational? Identify the
competitive advantages that a firm in each category must have to be a
successful multinational.
(A) Raw materials seekers

(B) Market seekers
(C) Cost minimizers
ANSWER:
Raw materials seekers: The existence of low-cost raw materials overseas is not a
sufficient condition for these firms to become multinational; they could just import raw
materials rather than set up operations abroad to extract them. Companies that become
raw materials MNCs must:
• have intangible capabilities in the form of technical skills.

• face problems of opportunism that make it very expensive to enter long-term
purchase contracts to fully utilize their production or distribution capability. For
example, an oil refining and distributing firm may find it too risky to invest in further
refining capacity without controlling its own oil supply.
Market seekers: These firms usually have intangible capital in the form of organizational
skills that are inseparable from the firm itself.
• A basic skill involves knowledge about how best to service a market, including new
product development and adaptation, quality control, advertising, distribution, and
after-sales service.
• Since it would be difficult, if not impossible, to unbundle these services and sell them
apart from the firm, this form of market imperfection often leads to corporate attempts
to exert control directly via the establishment of foreign affiliates.
Cost minimizers: These firms seek to reduce their costs by producing overseas.
• Yet the existence of lower-cost production sites overseas is not sufficient to justify
FDI.
• Since local firms have an inherent cost advantage over foreign investors,
multinationals can succeed abroad only if the production or marketing edge they
possess cannot be purchased or duplicated by local competitors.
▪ The successful MNC in this category will possess specialized design or marketing
skill, a good distribution system, or own a strong brand name.
▪ Excess profits are earned on these intangible assets, not on the low foreign labor or
materials costs.
▪ Overseas production just enables them to be cost competitive; it doesn't give them an
edge since any competitor can replicate its production location.
Q2(A): Why do companies generally follow a sequential strategy in moving
overseas?
ANSWER:
Q2(A): Why do companies generally follow a sequential strategy in moving
overseas?
ANSWER:
The usual sequence of overseas expansion involves:

• exporting,
• setting up a foreign sales subsidiary,
• possible licensing agreements, and
• foreign production.
This sequential approach can be viewed as a risk-minimizing response to operating in a

highly uncertain foreign environment.
By internationalizing in phases, a firm can gradually move from a relatively low risk-low
return, export-oriented strategy to a higher risk-higher return strategy emphasizing
international production.
In effect, the firm is investing in information, learning enough at each stage to

significantly improve its chances for success at the next stage.
Q2(B): What are the pluses and minuses of exporting? Licensing? Of foreign
production?
ANSWER:
Q2(B): What are the pluses and minuses of exporting? Licensing? Of foreign
production?
ANSWER:
Exporting is a low-cost, low-risk strategy for learning about and developing foreign
markets.
At the same time, it limits a company's ability to fully exploit foreign markets.
By producing abroad, a company can more easily keep abreast of market developments,
adapt its products to local tastes and conditions, and provide more comprehensive after-
sales service.
And while foreign production often requires a substantial capital investment, it may allow
a company to access lower cost local labor and materials.
It also demonstrates a tangible commitment to the local market and an increased

assurance of supply stability.
Instead of spending the money to set up production facilities abroad, the company can
license a local firm to manufacture its products.
Licensing also allows the company to access its licensee's marketing smarts and
distribution network.
But licensing may create a competitor in other markets because it is often difficult to
control exports by foreign licensees.
It may also be difficult to displace the licensee in the local market once the license
expires.
Q3: What factors help determine whether a firm will export its output, license
foreign companies to manufacture its products, or set up its own production
or service facilities abroad? Identify the competitive advantages that lead
companies to prefer one mode of international expansion over another.
ANSWER:
Q3: What factors help determine whether a firm will export its output, license
foreign companies to manufacture its products, or set up its own production
or service facilities abroad? Identify the competitive advantages that lead
companies to prefer one mode of international expansion over another.
ANSWER:
Here are some factors involved in deciding how to enter a market:
Production economies of scale: If these are important, then exporting might be the
appropriate answer.
Trade barriers: Companies that might otherwise be inclined to export to a market may be
forced by regulations to produce abroad, either in a wholly-owned operation, a joint
venture, or through a licensing arrangement with a local manufacturer.
Transportation costs: These have the same effect as trade barriers. The more expensive
it is to ship a product to a market, the more likely it is that local production will take place.
Size of the foreign market: The larger the local market, the more likely local production is
to take place, particularly if there are significant production economies of scale.
Conversely, with smaller markets, exporting is more likely to take place.
Production costs: The real exchange rate, wage rates, and other cost factors will also
play a part in determining whether exporting or local production takes place.
Intangible capital: If the multinational's intangible capital is embodied in the form of

products, then exporting will generally be preferred. If this intangible capital takes the
form of specific product or process technologies that can be written down and transmitted
objectively, then foreign expansion will usually take the licensing route. But if this
intangible capital takes the form of organizational skills that are inseparable from the firm
itself, then the firm is likely to expand overseas via direct investment.
Necessity of a foreign market presence: By investing in fixed assets abroad, companies

can demonstrate to local customers their commitment to the market. This can enhance
sales prospects.
Q5: Given the added political and economic risks that appear to exist overseas,
are multinational firms more or less risky than purely domestic firms in the
same industry? Consider whether a firm that decides not to operate abroad
is insulated from the effects of economic events that occur outside the home
country.
ANSWER:
Q5: Given the added political and economic risks that appear to exist overseas,
are multinational firms more or less risky than purely domestic firms in the
same industry? Consider whether a firm that decides not to operate abroad
is insulated from the effects of economic events that occur outside the home
country.
ANSWER:
❑ Individual foreign projects may face more political and economic risks than
comparable domestic projects.
❑ Yet, multinationals are likely to be less risky than purely domestic firms.
❑ The reason is that much of the risk faced overseas is diversifiable risk.
❑ Moreover, by operating and producing overseas, the multinational firm has

diversified its cost and revenue structure relative to what it would be if it were a
purely domestic firm producing and selling in the home market.
❑ It is important to note that domestic firms are not insulated from economic changes
abroad.
❑ For example, domestic firms face exchange risk since their competitive position
depends on the cost structure of their foreign competitors as well as their domestic
competitors.
❑ Similarly, changes in the price of oil and other materials abroad immediately lead to
changes in domestic prices.
Q1: Suppose the worldwide profit breakdown for General Motors is 85 percent in
the United States, 3 percent in Japan, and 12 percent in the rest of the world.
Its principal Japanese competitors earn 40 percent of their profits in Japan,
25 percent in the United States, and 35 percent in the rest of the world.
Suppose further that through diligent attention to productivity and
substitution of enormous quantities of capital for labor (for example, Project
Saturn), GM manages to get its automobile production costs down to the
level of the Japanese.
(A): Who is likely to have the global competitive advantage? Consider, for
example, the ability of GM to respond to a Japanese attempt to gain U.S.
market share through a sharp price cut.
ANSWER:
Q1: Suppose the worldwide profit breakdown for General Motors is 85 percent in
the United States, 3 percent in Japan, and 12 percent in the rest of the world.
Its principal Japanese competitors earn 40 percent of their profits in Japan,
25 percent in the United States, and 35 percent in the rest of the world.
Suppose further that through diligent attention to productivity and
substitution of enormous quantities of capital for labor (for example, Project
Saturn), GM manages to get its automobile production costs down to the
level of the Japanese.
(A): Who is likely to have the global competitive advantage? Consider, for
example, the ability of GM to respond to a Japanese attempt to gain U.S.
market share through a sharp price cut.
ANSWER:
❑ Even if GM manages to get its costs down to the level of its Japanese competitors,
it will still face a competitive disadvantage because of asymmetrical market shares.
❑ Suppose the Japanese cut their prices in order to gain market share in the United
States.
❑ If GM responds with its own price cuts, it will lose profit on 85% of its sales.
❑ By contrast, the Japanese will lose profit on only 25% of their sales.
❑ This puts GM in a bind: If its responds to this competitive intrusion with a price cut
of its own, the response will hurt GM more than the Japanese.
(B): How might GM respond to the Japanese challenge?
ANSWER:
❑ If GM responds with its own price cuts, it will lose profit on 85% of its sales.
❑ By contrast, the Japanese will lose profit on only 25% of their sales.
❑ This puts GM in a bind: If its responds to this competitive intrusion with a price cut
of its own, the response will hurt GM more than the Japanese.
(B): How might GM respond to the Japanese challenge?
ANSWER:
❑ GM could reduce its costs still further through some major technological
breakthroughs, by cutting wages and benefits, or by sourcing more parts and
components abroad.
❑ It could also improve its product differentiation in ways that are valued by auto
buyers.
❑ Alternatively, GM could cut price in Japan.

(C): Which competitive response would you recommend to GM's CEO?
ANSWER:
(C): Which competitive response would you recommend to GM's CEO?
ANSWER:
❑ GM is actively engaged in various cost cutting activities and this activity should
continue regardless of what the Japanese do; it is not directly tied to their behavior.
❑ The second response--better product differentiation--is problematic given GM's past

history.
❑ The third alternative is the one to focus on. The correct place for GM to retaliate
against a Japanese competitive intrusion in the U.S. is Japan, where their
competitors earn 40% of their profits. This response would hurt the Japanese more
than GM. But in order to make this retaliatory threat credible, GM must build up its
Japanese market position, a tall order for any U.S. firm.
Q8: Early results on the Lexus, Toyota's upscale car, showed it was taking the
most business from customers changing from either BMW (15 percent),
Mercedes (14 percent), Toyota (14 percent), General Motors' Cadillac (12
percent), and Ford's Lincoln (6 percent). With what in the auto business is
considered a high percentage of sales coming from its own customers, how
badly is Toyota hurting itself with the Lexus?
ANSWER:
Q8: Early results on the Lexus, Toyota's upscale car, showed it was taking the
most business from customers changing from either BMW (15 percent),
Mercedes (14 percent), Toyota (14 percent), General Motors' Cadillac (12
percent), and Ford's Lincoln (6 percent). With what in the auto business is
considered a high percentage of sales coming from its own customers, how
badly is Toyota hurting itself with the Lexus?
ANSWER:
❑ Toyota appears to be hurting itself with Lexus.
❑ But, in fact, Lexus is doing exactly what Toyota intended: retaining customers, since
Toyota determined that many of its customers who switched to Lexus were ready to
"trade up" to a luxury car.
❑ Now Toyota's customers are trading up to a Lexus instead of a BMW or Mercedes.
❑ The key point is that the cannibalization is more apparent than real: If Toyota had not
built the Lexus, it would have lost these customers anyway, but to another company
Q1: In the beginning stages of the exporting process, a major challenge is the
A. firm’s inexperienced staff

B. lack of knowledge concerning foreign custom’s regulations
C. fear of the unknown foreign business customs
D. ability to realize the full sales potential of a product.
ANSWER:
Q1: In the beginning stages of the exporting process, a major challenge is the
A. firm’s inexperienced staff

B. lack of knowledge concerning foreign custom’s regulations
C. fear of the unknown foreign business customs
D. ability to realize the full sales potential of a product.
ANSWER: “D”
Q2: Firms who wish to go global but who are not ready to assume significant risk may
resort to ____________ in order to compete internationally.
A. licensing a local firm to manufacture the company’s products

B. acquiring a local operation
C. government subsidized exporting programs
D. setting up a local factory
ANSWER:
Q2: Firms who wish to go global but who are not ready to assume significant risk may
resort to ____________ in order to compete internationally.
A. licensing a local firm to manufacture the company’s products

B. acquiring a local operation
C. government subsidized exporting programs
D. setting up a local factory
ANSWER: “A”
Q3: Foreign direct investment would be the acquisition abroad by the MNC of
A. sales offices
B. distribution channels
C. plant and equipment
D. portfolio securities
ANSWER:
Q3: Foreign direct investment would be the acquisition abroad by the MNC of
A. sales offices
B. distribution channels
C. plant and equipment
D. portfolio securities
ANSWER: “C”
Q4: The most important element in determining whether and how a firm should expand
overseas is
A. the degree of government subsidies and protection provided

B. whether the firm's competitive advantages can be transferred abroad and how this
can best be done
C. the correlation between the domestic and world economies
D. the extent of political risk overseas
ANSWER:
Q4: The most important element in determining whether and how a firm should expand
overseas is
A. the degree of government subsidies and protection provided

B. whether the firm's competitive advantages can be transferred abroad and how this
can best be done
C. the correlation between the domestic and world economies
D. the extent of political risk overseas
ANSWER: “B”
Q5: The choice of whether to sell abroad by exporting, licensing foreign producers, or
manufacturing abroad depends on all of the following EXCEPT
A. the nature of government regulations

B. whether the firm's competitive advantage can be transferred abroad in the
products it sells or can be written down and clearly transmitted
C. whether customers are looking for some signals as to the firm's commitment to the
local market
D. transfer pricing policies of the parent MNC
ANSWER:
Q5: The choice of whether to sell abroad by exporting, licensing foreign producers, or
manufacturing abroad depends on all of the following EXCEPT
A. the nature of government regulations

B. whether the firm's competitive advantage can be transferred abroad in the
products it sells or can be written down and clearly transmitted
C. whether customers are looking for some signals as to the firm's commitment to the
local market
D. transfer pricing policies of the parent MNC
ANSWER: “D”
The following information is used for the next TWO questions.
You work for a firm whose home currency is the Russian ruble (RUB) and that is
considering a foreign investment. The investment yields expected after-tax euro
(EUR) cash flows (in millions) as follows:
Year 0 Year 1 Year 2 Year 3
–EUR1,000 EUR450 EUR450 EUR450
Expected inflation is 9.0% in the Russian ruble and 11.0% in the euro. Assume that
the international parity conditions hold.
Required returns for projects in this risk class are:

• iRUB = 20.0% in Russian ruble; and
• iEUR = 22.2018% in euro
The spot exchange rate is SRUB/EUR 0 = RUB 72.500/EUR.

Q1: What is the NPV of the investment from the parent’s perspective? That is,
calculate NPVRUB 0 |iRUB by first converting the euro future cash flows into Russian
ruble equivalents at expected future spot rates (based on relative PPP) and then
discount these cash flows at the appropriate risk-adjusted rate in the Russian
ruble.
ANSWER:
Q1: What is the NPV of the investment from the parent’s perspective? That is,
calculate NPVRUB 0 |iRUB by first converting the euro future cash flows into Russian
ruble equivalents at expected future spot rates (based on relative PPP) and then
discount these cash flows at the appropriate risk-adjusted rate in the Russian
ruble.
ANSWER:
Parent (domestic currency) = Russian Ruble (RUB)

Subsidiary (foreign currency) = Euro (EUR)
Inflation rate (domestic market) = 9.0% in the Russian Ruble

Inflation rate (foreign market) = 11.0% in the Euro
Required return (domestic market) = 20.0% in the Russian Ruble

Required return (foreign market) = 22.2018% in the Euro
SRUB/EUR 0 = RUB 72.500/EUR

Convert the cash flows to the parent (domestic) currency and value the project using
domestic discount rates.
Step 1: Calculate future spot rates based on relative PPP
YEAR 0 YEAR 1 YEAR 2 YEAR 3

CASH FLOWS (EUR) -1000 450 450 450
FUTURE RATES (RUB/EUR) 72.5 71.1937 69.9109 68.6513
Year 0 = 72.5 x (1.09/1.11)0 = 72.5
Year 1 = 72.5 x (1.09/1.11)1 = 71.1937
Year 2 = 72.5 x (1.09/1.11)2 = 69.9109
Year 3= 72.5 x (1.09/1.11)3 = 68.6513
Step 2: Calculate NPV from the Parent’s perspective:
NPV (Parent) = -1000 x 72.5 + 450 x 71.1937 + 450 x 69.9109 + 450 x 68.6513
(1.20)1 (1.20)2 (1.20)3
NPV = -72,500 + 32,037.16 + 31,459.92 + 30,893.07

(1.20)1 (1.20)2 (1.20)3
NPV = -6,077.23 M (RUB)
The NPV from the parent’s perspective is −RUB 6,077.27 million.

considering a foreign investment. The investment yields expected after-tax euro
(EUR) cash flows (in millions) as follows:
–EUR1,000 EUR450 EUR450 EUR450
Expected inflation is 9.0% in the Russian ruble and 11.0% in the euro. Assume that
the international parity conditions hold.

• iRUB = 20.0% in Russian ruble; and
• iEUR = 22.2018% in euro
The spot exchange rate is SRUB/EUR 0 = RUB 72.500/EUR.

Q2: What is the NPV of the investment from the project’s perspective? That is,
calculate NPVRUB 0 |iEUR by discounting the euro cash flows at the appropriate risk-
adjusted euro discount rate and then convert this value into Russian ruble at the
today’s current spot rate.
ANSWER:
Q2: What is the NPV of the investment from the project’s perspective? That is,
calculate NPVRUB 0 |iEUR by discounting the euro cash flows at the appropriate risk-
adjusted euro discount rate and then convert this value into Russian ruble at the
today’s current spot rate.
ANSWER:
Parent (domestic currency) = Russian Ruble (RUB)

Subsidiary (foreign currency) = Euro (EUR)
Inflation rate (domestic market) = 9.0% in the Russian Ruble

Inflation rate (foreign market) = 11.0% in the Euro
Required return (domestic market) = 20.0% in the Russian Ruble

Required return (foreign market) = 22.2018% in the Euro
SRUB/EUR 0 = RUB 72.500/EUR

Calculate NPV from the Project’s perspective:
Project’s Perspective: Value the project in the foreign currency (the present value of cash
flows and discount rates in the foreign currency) and then current the value of the project
into the parent’s (domestic) currency.
NPV = 72.5 -1000 + 450 + 450 + 450 .

(1.222018)1 (1.222018)2 (1.222018) 3
NPV = -6,077.23 M (RUB)
The NPV from the project’s perspective is −RUB 6,077.23 million.

The following information is used for the next THREE questions.
You work for a firm whose home currency is the Swiss franc (CHF) and that is
considering a foreign investment. The investment yields expected after-tax British
pound (GBP) cash flows (in millions) as follows:

–GBP900 GBP400 GBP400 GBP400
Expected inflation is 13.0% in the Swiss franc and 6.0% in the British pound.

• iCHF = 19.3% in the Swiss franc; and
• iGBP = 22.3% in the British pound
The spot exchange rate is SCHF/GBP 0 = CHF 1.4206/GBP.

Q3: What is the NPV of the investment from the project’s perspective?
ANSWER:
ANSWER:
Parent (domestic currency) = Swiss franc (CHF)

Subsidiary (foreign currency) = British pound (GBP)
Inflation rate (domestic market) = 13.0% in the Swiss franc

Inflation rate (foreign market) = 6.0% in the British pound
Required return (domestic market) = 19.3% in the Swiss franc

Required return (foreign market) = 22.3% in the British pound
SCHF/GBP 0 = CHF 1.4206/GBP

NPV = 1.4206 -900 + 400 + 400 + 400 .

(1.223)1 (1.223)2 (1.223)3
NPV = -123.367 M (CHF)
The NPV from the project’s perspective is −CHF 123.37 million.

You work for a firm whose home currency is the Swiss franc (CHF) and that is
considering a foreign investment. The investment yields expected after-tax British
pound (GBP) cash flows (in millions) as follows:

–GBP900 GBP400 GBP400 GBP400
Expected inflation is 13.0% in the Swiss franc and 6.0% in the British pound.

• iCHF = 19.3% in the Swiss franc; and
• iGBP = 22.3% in the British pound
The spot exchange rate is SCHF/GBP 0 = CHF 1.4206/GBP.

Q4: What is the NPV of the investment from the parent’s perspective?
ANSWER:
ANSWER:
Parent (domestic currency) = Swiss franc (CHF)

Subsidiary (foreign currency) = British pound (GBP)
Inflation rate (domestic market) = 13.0% in the Swiss franc

Inflation rate (foreign market) = 6.0% in the British pound
Required return (domestic market) = 19.3% in the Swiss franc

Required return (foreign market) = 22.3% in the British pound
SCHF/GBP 0 = CHF 1.4206/GBP


CASH FLOWS (GBP) -900 400 400 400
FUTURE RATES (CHF/GBP) 1.4206 1.5144 1.6144 1.7210
Year 0 = 1.4206 x (1.13/1.06)0 = 1.4206
Year 1 = 1.4206 x (1.13/1.06)1 = 1.5144
Year 2 = 1.4206 x (1.13/1.06)2 = 1.6144
Year 3= 1.4206 x (1.13/1.06)3 = 1.7210
NPV (Parent) = -900 x 1.4206 + 400 x 1.5144 + 400 x 1.6144 + 400 x 1.7210
(1.193)1 (1.193)2 (1.193)3
NPV = -1,278.54 + 605.7653 + 645.7687 + 688.4138 .

(1.193)1 (1.193)2 (1.193)3
NPV = 88.3964 M (CHF)
The NPV from the parent’s perspective is CHF 88.40 million.

What is the correct course of action for the managers of the firm?
a. Accept the project and then, depending on the corporation’s tolerance for
risk, potentially leave the investment unhedged to take advantage of the
expected real appreciation of the project’s local currency (the British pound)
against the parent company’s home currency (the Swiss franc).
b. Accept the project and then hedge or otherwise capture the project’s value
if possible, as leaving the project unhedged is expected to reduce the magnitude
of the positive NPV for the parent due to the forecast real depreciation
of the British pound against the Swiss franc.
c. Accept the project only if it is possible to hedge or otherwise structure
the deal to lock in the positive British pound project value in the parent
company’s domestic Swiss franc terms.
d. Reject the project but keep looking for positive-NPV projects in the British
pound due to favorable exchange rate forecasts in its real value against the
Swiss franc.
e. Reject the project. It is both a bad project and there are unfavorable
exchange rate forecasts.
ANSWER:
expected real appreciation of the project’s local currency (the British pound)
against the parent company’s home currency (the Swiss franc).
b. Accept the project and then hedge or otherwise capture the project’s value
of the British pound against the Swiss franc.
c. Accept the project only if it is possible to hedge or otherwise structure
the deal to lock in the positive British pound project value in the parent
company’s domestic Swiss franc terms.
d. Reject the project but keep looking for positive-NPV projects in the British
pound due to favorable exchange rate forecasts in its real value against the
Swiss franc.
ANSWER: ‘D’
considering a foreign investment. The investment yields expected after-tax
Swedish krona (SEK) cash flows (in millions) as follows:

–SEK1,100 SEK750 SEK750 SEK750
Expected inflation is 4.0% in the Russian ruble and 34.0% in the Swedish krona.

• iRUB = 18.8% in the Russian ruble; and
• iSEK = 36.5% in the Swedish krona
The spot exchange rate is SRUB/SEK 0 = RUB 6.3315/SEK.

ANSWER:
ANSWER:
Parent (domestic currency) = Russian ruble (RUB)

Subsidiary (foreign currency) = Swedish krona (SEK)
Inflation rate (domestic market) = 4.0% in the Russian ruble

Inflation rate (foreign market) = 34.0% in the Swedish krona
Required return (domestic market) = 18.8% in the Russian ruble

Required return (foreign market) = 36.5% in the Swedish krona
SRUB/SEK 0 = RUB 6.3315/SEK


CASH FLOWS (SEK) -1,100 750 750 750
FUTURE RATES (RUB/SEK) 6.3315 4.9140 3.8139 2.9600
Year 0 = 6.3315 x (1.04/1.34)0 = 6.3315
Year 1 = 6.3315 x (1.04/1.34)1 = 4.9140
Year 2 = 6.3315 x (1.04/1.34)2 = 3.8139
Year 3= 6.3315 x (1.04/1.34)3 = 2.9600
NPV (Parent) = -1,100 x 6.3315 + 750 x 4.9140 + 750 x 3.8139 + 750 x 2.9600
(1.188)1 (1.188)2 (1.188)3
NPV = -6,964.65 + 3,685.50 + 2,860.3881 + 2,220.0027 .

(1.188)1 (1.188)2 (1.188)3
NPV = -511.616 M (RUB)
The NPV from the parent’s perspective is –RUB 511.62 million.

Swedish krona (SEK) cash flows (in millions) as follows:

–SEK1,100 SEK750 SEK750 SEK750
Expected inflation is 4.0% in the Russian ruble and 34.0% in the Swedish krona.

• iRUB = 18.8% in the Russian ruble; and
• iSEK = 36.5% in the Swedish krona
The spot exchange rate is SRUB/SEK 0 = RUB 6.3315/SEK.

ANSWER:
ANSWER:
Parent (domestic currency) = Russian ruble (RUB)

Subsidiary (foreign currency) = Swedish krona (SEK)
Inflation rate (domestic market) = 4.0% in Russian ruble

Inflation rate (foreign market) = 34.0% in Swedish krona
Required return (domestic market) = 18.8% in the Russian ruble; and

Required return (foreign market) = 36.5% in the Swedish krona
SRUB/SEK 0 = RUB 6.33115/SEK

NPV = 6.3315 -1100 + 750 + 750 + 750 .

(1.365)1 (1.365)2 (1.365)3
NPV = 929.9115 M (RUB)
The NPV from the project’s perspective is RUB 929.91 million.

expected real appreciation of the project’s local currency (the Swedish krona)
against the parent company’s home currency (the Russian ruble).
b. Accept the project only if it is possible to hedge or otherwise structure
the deal to lock in the positive Swedish krona project value in the parent
company’s domestic Russian ruble terms.
c. Reject the project. It is both a bad project and there are unfavorable
d. Accept the project and then hedge or otherwise capture the project’s value
of the Swedish krona against the Russian ruble.
e. Reject the project but keep looking for positive-NPV projects in the Swedish
krona due to favorable exchange rate forecasts in its real value against the
Russian ruble.
ANSWER:
expected real appreciation of the project’s local currency (the Swedish krona)
against the parent company’s home currency (the Russian ruble).
the deal to lock in the positive Swedish krona project value in the parent
company’s domestic Russian ruble terms.
c. Reject the project. It is both a bad project and there are unfavorable
d. Accept the project and then hedge or otherwise capture the project’s value
of the Swedish krona against the Russian ruble.
e. Reject the project but keep looking for positive-NPV projects in the Swedish
krona due to favorable exchange rate forecasts in its real value against the
Russian ruble.
ANSWER: ‘B’
You work for a firm whose home currency is the Japanese yen (JPY) and that is
considering a foreign investment. The investment yields expected after-tax Danish
krone (DKK) cash flows (in millions) as follows:

–DKK800 DKK475 DKK475 DKK475
Expected inflation is 7.0% in the Japanese yen and 24.0% in the Danish krone.

• iJPY = 11.0% in the Japanese yen; and
• iDKK = 32.3% in the Danish krone
The spot exchange rate is SJPY/DKK 0 = JPY 20.239/DKK.

ANSWER:
ANSWER:
Parent (domestic currency) = Japanese yen (JPY)

Subsidiary (foreign currency) = Danish krone (DKK)
Inflation rate (domestic market) = 7.0% in the Japanese yen

Inflation rate (foreign market) = 24.0% in the Danish krone
Required return (domestic market) = 11.0% in the Japanese yen

Required return (foreign market) = 32.3% in the Danish krone
SJPY/DKK 0 = JPY 20.239/DKK


CASH FLOWS (DKK) -800 475 475 475
FUTURE RATES (JPY/DKK) 20.2390 17.4643 15.0700 13.0040
Year 0 = 20.239 x (1.07/1.24)0 = 20.2390
Year 1 = 20.239 x (1.07/1.24)1 = 17.4643
Year 2 = 20.239 x (1.07/1.24)2 = 15.0700
Year 3= 20.239 x (1.07/1.24)3 = 13.0040
NPV (Parent) = -800 x 20.2390 + 475 x 17.4643 + 475 x 15.0700 + 475 x 13.0040
(1.11)1 (1.11)2 (1.11)3
NPV = -16,191.20 + 8,295.5417 + 7,158.2497 + 6,176.8768 .

(1.11)1 (1.11)2 (1.11)3
NPV = 1,608.536 M (JPY)
The NPV from the parent’s perspective is JPY 1,608.54 million.

You work for a firm whose home currency is the Japanese yen (JPY) and that is
considering a foreign investment. The investment yields expected after-tax Danish
krone (DKK) cash flows (in millions) as follows:

–DKK800 DKK475 DKK475 DKK475
Expected inflation is 7.0% in the Japanese yen and 24.0% in the Danish krone.

• iJPY = 11.0% in the Japanese yen; and
• iDKK = 32.3% in the Danish krone
The spot exchange rate is SJPY/DKK 0 = JPY 20.239/DKK.

ANSWER:
ANSWER:
Parent (domestic currency) = Japanese yen (JPY)

Subsidiary (foreign currency) = Danish krone (DKK)
Inflation rate (domestic market) = 7.0% in the Japanese yen

Inflation rate (foreign market) = 24.0% in the Danish krone
Required return (domestic market) = 11.0% in the Japanese yen

Required return (foreign market) = 32.3% in the Danish krone
SJPY/DKK 0 = JPY 20.239/DKK

NPV = 20.239 -800 + 475 + 475 + 475 .

(1.323)1 (1.323)2 (1.323)3
NPV = 719.1508 M (JPY)
The NPV from the project’s perspective is JPY 719.15 million.

a. Reject the project but keep looking for positive-NPV projects in the Danish
krone due to favorable exchange rate forecasts in its real value against the
Japanese yen.
the deal to lock in the positive Danish krone project value in the parent
company’s domestic Japanese yen terms.
c. Accept the project and then hedge or otherwise capture the project’s value
of the Danish krone against the Japanese yen.
d. Reject the project. It is both a bad project and there are unfavorable
e. Accept the project and then, depending on the corporation’s tolerance for
expected real appreciation of the project’s local currency (the Danish krone)
against the parent company’s home currency (the Japanese yen).
ANSWER:
a. Reject the project but keep looking for positive-NPV projects in the Danish
krone due to favorable exchange rate forecasts in its real value against the
Japanese yen.
the deal to lock in the positive Danish krone project value in the parent
company’s domestic Japanese yen terms.
of the Danish krone against the Japanese yen.
d. Reject the project. It is both a bad project and there are unfavorable
e. Accept the project and then, depending on the corporation’s tolerance for
expected real appreciation of the project’s local currency (the Danish krone)
against the parent company’s home currency (the Japanese yen).
ANSWER: ‘E’
You work for a firm whose home currency is the British pound (GBP) and that is
considering a foreign investment. The investment yields expected after-tax Swiss
franc (CHF) cash flows (in millions) as follows:

–CHF1,500 CHF700 CHF700 CHF700
Expected inflation is 15.0% in the British pound and 20.0% in the Swiss franc.

• iGBP = 11.0% in the British pound; and
• iCHF = 11.7% in the Swiss franc
The spot exchange rate is SGBP/CHF 0 = GBP 0.7709/CHF.

ANSWER:
ANSWER:
Parent (domestic currency) = British pound (GBP)

Subsidiary (foreign currency) = Swiss franc (CHF)
Inflation rate (domestic market) = 15.0% in the British pound

Inflation rate (foreign market) = 20.0% in the Swiss franc
Required return (domestic market) = 11.0% in the British pound

Required return (foreign market) = 11.7% in the Swiss franc
SGBP/CHF 0 = GBP 0.7709/CHF

NPV = 0.7709 -1500 + 700 + 700 + 700 .

(1.117)1 (1.117)2 (1.117)3
NPV = 146.4612 M (GBP)
The NPV from the project’s perspective is GBP 146.46 million.

You work for a firm whose home currency is the British pound (GBP) and that is
considering a foreign investment. The investment yields expected after-tax Swiss
franc (CHF) cash flows (in millions) as follows:

–CHF1,500 CHF700 CHF700 CHF700
Expected inflation is 15.0% in the British pound and 20.0% in the Swiss franc.

• iGBP = 11.0% in the British pound; and
• iCHF = 11.7% in the Swiss franc
The spot exchange rate is SGBP/CHF 0 = GBP 0.7709/CHF.

ANSWER:
ANSWER:
Parent (domestic currency) = British pound (GBP)

Subsidiary (foreign currency) = Swiss franc (CHF)
Inflation rate (domestic market) = 15.0% in the British pound

Inflation rate (foreign market) = 20.0% in the Swiss franc
Required return (domestic market) = 11.0% in the British pound

Required return (foreign market) = 11.7% in the Swiss franc
SGBP/CHF 0 = GBP 0.7709/CHF


CASH FLOWS (CHF) -1,500 700 700 700
FUTURE RATES (GBP/CHF) 0.7709 0.7388 0.7080 0.6785
Year 0 = 0.7709 x (1.15/1.20)0 = 0.7709
Year 1 = 0.7709 x (1.15/1.20)1 = 0.7388
Year 2 = 0.7709 x (1.15/1.20)2 = 0.7080
Year 3= 0.7709 x (1.15/1.20)3 = 0.6785
NPV (Parent) = -1,500 x 0.7709 + 700 x 0.7388 + 700 x 0.7080 + 700 x 0.6785
(1.11)1 (1.11)2 (1.11)3
NPV = -1,156.35 + 517.1454 + 495.5977 + 474.9478 .

(1.11)1 (1.11)2 (1.11)3
NPV = 59.0627 M (GBP)
The NPV from the parent’s perspective is GBP 59.06 million.

a. Accept the project only if it is possible to hedge or otherwise structure the
deal to lock in the positive Swiss franc project value in the parent company’s
domestic British pound terms.
b. Accept the project and then, depending on the corporation’s tolerance for
expected real appreciation of the project’s local currency (the Swiss franc)
against the parent company’s home currency (the British pound).
of the Swiss franc against the British pound.
d. Reject the project but keep looking for positive-NPV projects in the Swiss
franc due to favorable exchange rate forecasts in its real value against the
British pound.
ANSWER:
a. Accept the project only if it is possible to hedge or otherwise structure the
deal to lock in the positive Swiss franc project value in the parent company’s
domestic British pound terms.
b. Accept the project and then, depending on the corporation’s tolerance for
expected real appreciation of the project’s local currency (the Swiss franc)
against the parent company’s home currency (the British pound).
of the Swiss franc against the British pound.
d. Reject the project but keep looking for positive-NPV projects in the Swiss
franc due to favorable exchange rate forecasts in its real value against the
British pound.
ANSWER: ‘C’
The following information is used for the next TWO questions.
You work for a firm whose home currency is the Brazilian real (BRL) and that is
considering a foreign investment. The investment yields expected after-tax United
States dollar (USD) cash flows (in millions) as follows:

–USD1,000 USD500 USD500 USD500
Expected inflation is 9.0% in the Brazilian real and 12.0% in the United States
dollar. Assume that the international parity conditions hold.

• iBRL = 12.0% in Brazilian real; and
• iUSD = 15.083% in United States dollar
The spot exchange rate is SBRL/USD 0 = BRL 3.8458/USD.

The project country’s government has United States dollar-denominated bonds
outstanding that currently yield 6.09% per annum. Your firm pays a marginal
corporate tax rate of 25% on its United States dollar profits, which is the same
marginal tax rate that your firm pays on its parent company profits in Brazilian
real.
Suppose that all of the United States dollar cash flows generated by the project
must be loaned to the country’s government at an interest rate of 0% per annum
for a period of exactly one year after they are generated by the project. Factoring in
the opportunity cost of the blocked funds, what is the NPV of the project?
ANSWER:
How to treat blocked fund?

- Calculate the opportunity cost i.e. the loss of value of funds cannot be invested until
one year after the project.
- The cash flows would have been invested in US dollar dominated bonds (6.09% per
annum could have been earned).
- The after-tax discount rate for blocked funds = 6.09% (1- 0.25) = 4.57%
USD NPVproject = -1000 + 500 + 500 + 500 .

(1.15083)1 (1.15083)2 (1.15083) 3
NPVproject = USD 140.0430 M

Step 1: Calculate the after-tax value of blocked funds assuming they are not blocked.
Unblocked V0 = 500 + 500 + 500 .

(1.0457)1 (1.0457)2 (1.0457)3
= USD 1,372.67 M
Step 2: Calculate the after-tax value of blocked funds assuming they are blocked.
Blocked V0 = 500 + 500 + 500 .

(1.0457)2 (1.0457)3 (1.0457)4
= USD 1,312.68 M
Step 3: Calculate the opportunity cost of blocked funds and add it to NPV.
Net Vo = 1,312.68 – 1,372.67 = -USD 59.99 (opportunity cost of blocked funds)
NPVproject = (140.0430 – 59.99) x 3.8458 = BRL 307.87 M
The value of the project in the United States dollar prior to any side effects is 140.043
million.
The opportunity cost of the blocked funds in the United States dollar is 59.99 million.
The value of the project in the United States dollar after considering the side effects is
80.05 million.
Factoring in the opportunity cost of the blocked funds, the NPV of the project in the
parent firm’s home currency is BRL 307.87 million.
You work for a firm whose home currency is the Brazilian real (BRL) and that is
considering a foreign investment. The investment yields expected after-tax United
States dollar (USD) cash flows (in millions) as follows:

–USD1,000 USD500 USD500 USD500
Expected inflation is 9.0% in the Brazilian real and 12.0% in the United States
dollar. Assume that the international parity conditions hold.

• iBRL = 12.0% in Brazilian real; and
• iUSD = 15.083% in United States dollar
The spot exchange rate is SBRL/USD 0 = BRL 3.8458/USD.

The project country’s government has United States dollar-denominated bonds
outstanding that currently yield 6.09% per annum. Your firm pays a marginal
corporate tax rate of 25% on its United States dollar profits, which is the same
marginal tax rate that your firm pays on its parent company profits in Brazilian
real.
Suppose that all of the United States dollar cash flows generated by the project
must be loaned to the country’s government at an interest rate of 0% per annum
until one year after the completion of the project (i.e. until t=4). Factoring in the
opportunity cost of the blocked funds, what is the NPV of the project?
ANSWER:
After-tax discount rate for blocked funds = 6.09% x (1 – 0.25) = 4.57%
USD NPVproject = -1000 + 500 + 500 + 500 .

(1.15083)1 (1.15083)2 (1.15083)3
NPVproject = USD 140.0430 M
Step 1: Calculate the after-tax value of blocked funds assuming they are not blocked.
Unblocked V0 = 500 + 500 + 500 .

(1.0457)1 (1.0457)2 (1.0457)3
= USD 1,372.67 M
Step 2: Calculate the after-tax value of blocked funds assuming they are blocked.
Blocked V0 = 500 x 3 .
(1.0457)4
= USD 1,254.48 M
Step 3: Calculate the opportunity cost of blocked funds and add it to NPV.
Net Vo = 1,254.48 – 1,372.67 = -USD 118.19 (opportunity cost of blocked funds)
NPVproject = (140.0430 – 118.19) x 3.8458 = BRL 84.04 M

The value of the project in the United States dollar prior to any side effects is 140.043
million.
The opportunity cost of the blocked funds in the United States dollar is 118.19 million.
The value of the project in the United States dollar after considering the side effects is
21.853 million.
Factoring in the opportunity cost of the blocked funds, the NPV of the project in the
parent firm’s home currency is BRL 84.04 million.
The following information is used for the next ONE question only.
You work for a firm whose home currency is the Mexican peso (MXN) and that is
Russian ruble (RUB) cash flows (in millions) as follows:

–RUB2,400 RUB1,125 RUB1,125 RUB1,125
Assume that Covered Interest Rate Parity holds and that your firm’s management
believes that Relative Purchasing Power Parity is the best way to predict future
exchange rates over this investment’s time horizon. You also have the following
information:
MXN RUB
Government bond yield 10.24% p.a. 17.52% p.a.
Expected inflation 5.00% p.a. 13.00% p.a.
Project required return 18.650% p.a. 27.690% p.a.
The spot exchange rate is SMXN/RUB 0 = MXN 0.2526/RUB. Assume that your firm is
unable to find a way to capture the project’s Russian ruble value today through
mechanisms such as securitizing the project and selling the project to local
investors.
What is the gain in Mexican peso value that the parent company can expect to
receive by hedging the project’s cashflows using available forward rates as
opposed to leaving the investment unhedged?
Step 1: Calculate future spot rate using RPPP (inflation rate)

CASH FLOWS (RUB) -2400 1125 1125 1125
FUTURE RATES (MXN/RUB) 0.2526 0.2347 0.2181 0.2027

Year 0 = 0.2526 x (1.05/1.13)0 = 0.2526
Year 1 = 0.2526 x (1.05/1.13)1 = 0.2347
Year 2 = 0.2526 x (1.05/1.13)2 = 0.2181
Year 3= 0.2526 x (1.05/1.13)3 = 0.2027
Step 2: Calculate NPV
NPV (Parent) = -2400 x 0.2526 + 1125 x 0.2347 + 1125 x 0.2181 + 1125 x 0.2027
(1.18650)1 (1.18650)2 (1.18650)3
NPV = -606.24 + 264.0564 + 245.3622 + 227.9914 .

(1.18650)1 (1.18650)2 (1.18650)3
NPV = -72.9049 M MXN (Value of the unhedged project.)

Step 3: Now calculate forward spot rates using CIRP (interest rate)

CASH FLOWS (RUB) -2400 1125 1125 1125
FUTURE RATES (MXN/RUB) 0.2527 0.2370 0.2223 0.2085
Year 0 = 0.2526 x (1.1024/1.1752)0 = 0.2527
Year 1 = 0.2526 x (1.1024/1.1752)1 = 0.2370
Year 2 = 0.2526 x (1.1024/1.1752)2 = 0.2223
Year 3= 0.2526 x (1.1024/1.1752)3 = 0.2085
Step 2: Calculate NPV
NPV (Parent) = -2400 x 0.2527 + 1125 x 0.2370 + 1125 x 0.2223 + 1125 x 0.2085
(1.18650)1 (1.18650)2 (1.18650)3
NPV = -606.24 + 266.6557 + 250.1372 + 234.6419 .

(1.18650)1 (1.18650)2 (1.18650)3
NPV = -63.53 M MXN (Value of the project when hedged with forwards)
The value of the project unhedged is −MXN 72.90 million.
When hedged with forwards, it is worth −MXN 63.53 million.
Therefore, the gain to the Mexican peso value of the project from hedging using forwards
is MXN 9.37 million.

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INTERNATIONAL

BY: MISHAL MANZOOR

(A) Raw materials seekers

(A) Raw materials seekers

• have intangible capabilities in the form of technical skills.

The usual sequence of overseas expansion involves:

This sequential approach can be viewed as a risk-minimizing response to operating in a

In effect, the firm is investing in information, learning enough at each stage to

It also demonstrates a tangible commitment to the local market and an increased

Here are some factors involved in deciding how to enter a market:

Intangible capital: If the multinational's intangible capital is embodied in the form of

Necessity of a foreign market presence: By investing in fixed assets abroad, companies

❑ Moreover, by operating and producing overseas, the multinational firm has

(B): How might GM respond to the Japanese challenge?

(B): How might GM respond to the Japanese challenge?

❑ Alternatively, GM could cut price in Japan.

❑ The second response--better product differentiation--is problematic given GM's past

❑ Toyota appears to be hurting itself with Lexus.

❑ Now Toyota's customers are trading up to a Lexus instead of a BMW or Mercedes.

A. firm’s inexperienced staff

A. firm’s inexperienced staff

A. licensing a local firm to manufacture the company’s products

A. licensing a local firm to manufacture the company’s products

A. the degree of government subsidies and protection provided

A. the degree of government subsidies and protection provided

A. the nature of government regulations

A. the nature of government regulations

Required returns for projects in this risk class are:

The spot exchange rate is SRUB/EUR 0 = RUB 72.500/EUR.

Parent (domestic currency) = Russian Ruble (RUB)

Inflation rate (domestic market) = 9.0% in the Russian Ruble

Required return (domestic market) = 20.0% in the Russian Ruble

SRUB/EUR 0 = RUB 72.500/EUR

Step 1: Calculate future spot rates based on relative PPP

YEAR 0 YEAR 1 YEAR 2 YEAR 3

Step 2: Calculate NPV from the Parent’s perspective:

NPV = -72,500 + 32,037.16 + 31,459.92 + 30,893.07

NPV = -6,077.23 M (RUB)

The NPV from the parent’s perspective is −RUB 6,077.27 million.

Required returns for projects in this risk class are:

The spot exchange rate is SRUB/EUR 0 = RUB 72.500/EUR.

Parent (domestic currency) = Russian Ruble (RUB)

Inflation rate (domestic market) = 9.0% in the Russian Ruble

Required return (domestic market) = 20.0% in the Russian Ruble

SRUB/EUR 0 = RUB 72.500/EUR

NPV = 72.5 -1000 + 450 + 450 + 450 .

NPV = -6,077.23 M (RUB)

The NPV from the project’s perspective is −RUB 6,077.23 million.

Year 0 Year 1 Year 2 Year 3

Required returns for projects in this risk class are:

The spot exchange rate is SCHF/GBP 0 = CHF 1.4206/GBP.

Parent (domestic currency) = Swiss franc (CHF)

Inflation rate (domestic market) = 13.0% in the Swiss franc

Required return (domestic market) = 19.3% in the Swiss franc

SCHF/GBP 0 = CHF 1.4206/GBP

NPV = 1.4206 -900 + 400 + 400 + 400 .

NPV = -123.367 M (CHF)

The NPV from the project’s perspective is −CHF 123.37 million.