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Answers to End of Chapter Questions
1. Agency Problems of MNCs.
a. Explain the agency problem of MNCs.
ANSWER: The agency problem reflects a conflict of interests between decision-making managers
b. Why might agency costs be larger for an MNC than for a purely domestic firm?
ANSWER: The agency costs are normally larger for MNCs than purely domestic firms for the
2. Comparative Advantage.
a. Explain how the theory of comparative advantage relates to the need for international business.
ANSWER: The theory of comparative advantage implies that countries should specialize in
b. Explain how the product cycle theory relates to the growth of an MNC.
ANSWER: The product cycle theory suggests that at some point in time, the firm will attempt to
3. Imperfect Markets.
a. Explain how the existence of imperfect markets has led to the establishment of subsidiaries in
foreign markets.
ANSWER: Because of imperfect markets, resources cannot be easily and freely retrieved by the
b. Suppose perfect markets existed.Would If perfect markets existed, would wages, prices, and
interest rates among countries be more similar or less similar than under conditions of imperfect
markets? Why?
ANSWER: If perfect markets existed, resources would be more mobile and could therefore be
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Multinational Financial Management: An Overview 2
4. International Opportunities.
a. Do you think that either the acquisition of a foreign firm or licensing will result in greater growth
for an MNC? Which alternative is likely to have more risk?
ANSWER: An acquisition will typically result in greater growth, but it is more risky because it
b. Describe a scenario in which the size of a corporation is not affected by access to international
opportunities.
ANSWER: Some firms may avoid opportunities because they lack knowledge about foreign markets
c. Explain why MNCs such as Coca Cola and PepsiCo, Inc., still have numerous opportunities for
international expansion.
ANSWER: Coca Cola and PepsiCo still have new international opportunities because countries are at
5. International Opportunities Due to the Internet.
a. What factors cause some firms to become more internationalized than others?
ANSWER: The operating characteristics of the firm (what it produces or sells) and the risk perception
b. Offer your opinion on why the Internet may result in more international business.
ANSWER: The Internet allows for easy and low-cost communication between countries, so that firms
could now develop contacts with potential customers overseas by having a website. Many firms use
their website to identify the products that they sell, along with the prices for each product. This
6. Impact of Exchange Rate Movements. Plak Co. of Chicago has several European subsidiaries that
remit earnings to it each year. Explain how appreciation of the euro (the currency used in many
European countries) would affect Plak's valuation.
ANSWER: Plak’s valuation should increase because the appreciation of the euro will increase the
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Multinational Financial Management: An Overview 3
7. Benefits and Risks of International Business. As an overall review of this chapter, identify possible
reasons for growth in international business. Then, list the various disadvantages that may discourage
international business.
ANSWER: Growth in international business can be stimulated by (1) access to foreign resources
which can reduce costs, or (2) access to foreign markets which boost revenues. Yet, international
8. Valuation of an MNC. Hudson Co., a U.S. firm, has a subsidiary in Mexico, where political risk has
recently increased. Hudson's best guess of its future peso cash flows to be received has not changed.
However, its valuation has declined as a result of the increase in political risk. Explain.
ANSWER: The valuation of the MNC is the present value of expected cash flows. The increase in
9. Centralization and Agency Costs. Would the agency problem be more pronounced for Berkley
Corp., whose parent company makes most major decisions for its foreign subsidiaries, or Oakland
Corp., which uses a decentralized approach?
ANSWER: The agency problem would be more pronounced for Oakland because of a higher
probability that subsidiary decisions would conflict with the parent. Assuming that the parent
10. Global Competition. Explain why more standardized product specifications across countries can
increase global competition.
ANSWER: Standardized product specifications allow firms to more easily expand their business
11. Exposure to Exhange Rates. McCanna Corp., a U.S. firm, has a French subsidiary that produces
wine and exports to various European countries. All of the countries where it sells its wine use the
euro as their currency, which is the same as the currency used in France. Is McCanna Corp. exposed
to exchange rate risk?
ANSWER: The subsidiary and its customers based in countries that now use the euro as their
12. Macro versus Micro Topics. Review the table of contents and indicate whether each of the chapters
from Chapter 2 through Chapter 21 has a macro or micro perspective.
ANSWER: Chapters 2 through 8 are macro, while Chapters 9 through 21 are micro.
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Multinational Financial Management: An Overview 4
13. Methods Used to Conduct International Business. Duve, Inc., desires to penetrate a foreign market
with either a licensing agreement with a foreign firm or by acquiring a foreign firm. Explain the
differences in potential risk and return between licensing with a foreign firm, and acquiring a foreign
firm.
ANSWER: A licensing agreement has limited potential for return, because the foreign firm will
receive much of the benefits as a result of the licensing agreement. Yet, the MNC has limited risk,
because it did not need to invest substantial funds in the foreign country.
14. International Business Methods. Snyder Golf Co., a U.S. firm that sells high-quality golf clubs in
the U.S., wants to expand internationally by selling the same golf clubs in Brazil.
a. Describe the tradeoffs that are involved for each method (such as exporting, direct foreign
investment, etc.) that Snyder could use to achieve its goal.
ANSWER: Snyder can export the clubs, but the transportation expenses may be high. If could
establish a subsidiary in Brazil to produce and sell the clubs, but this may require a large investment
b. Which method of international method would you recommend for this firm? Justify your
recommendation.
ANSWER: If the amount of golf clubs to be sold in Brazil is small, it may decide to export. However,
if the expected sales level is high, it may benefit from licensing. If it is confident that the expected
15. Impact of Political Risk. Explain why political risk may discourage international business.
ANSWER: Political risk increases the rate of return required to invest in foreign projects. Some
16. Impact of September 11. Following the terrorist attack on the U.S., the valuations of many MNCs
declined by more than 10 percent. Explain why the expected cash flows of MNCs were reduced, even
if they were not directly hit by the attacks.
ANSWER: An MNC’s cash flows could be reduced in the following ways. First, a decline in travel
would affect any MNCs that have business in travel-related industries. The airline, hotel, and
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Multinational Financial Management: An Overview 5
Advanced Questions
17. International Joint Venture. Anheuser-Busch, (which is now part of AB InBev due to a merger), the
producer of Budweiser and other beers, has engaged in a joint venture with Kirin Brewery, the largest
brewery in Japan. The joint venture enables Anheuser-Busch to have its beer distributed through
Kirin’s distribution channels in Japan. In addition, it could utilize Kirin’s facilities to produce beer
that would be sold locally. In return, Anheuser-Busch provided information about the American beer
market to Kirin.
a. Explain how the joint venture enabled Anheuser-Busch to achieve its objective of maximizing
shareholder wealth.
ANSWER: The joint venture creates a way for Anheuser-Busch to distribute Budweiser throughout
b. Explain how the joint venture limited the risk of the international business.
ANSWER: The joint venture has limited risk because Anheuser-Busch does not need to establish its
c. Many international joint ventures are intended to circumvent barriers that normally prevent
foreign competition. What barrier in Japan did Anheuser-Busch circumvent as a result of the
joint venture? What barrier in the United States did Kirin circumvent as a result of the joint
venture?
ANSWER: Anheuser-Busch is able to benefit from Kirin’s distribution system in Japan, which would
d. Explain how Anheuser-Busch could have lost some of its market share in countries outside Japan
as a result of this particular joint venture.
ANSWER: Anheuser-Busch could lose some of its market share to Kirin as a result of explaining its
18. Impact of Eastern European Growth. The managers of Loyola Corp. recently had a meeting to
discuss new opportunities in Europe as a result of the recent integration among Eastern European
countries. They decided not to penetrate new markets because of their present focus on expanding
market share in the United States. Loyola’s financial managers have developed forecasts for earnings
based on the 12 percent market share (defined here as its percentage of total European sales) that
Loyola currently has in Eastern Europe. Is 12 percent an appropriate estimate for next year’s Eastern
European market share? If not, does it likely overestimate or underestimate next year’s actual Eastern
European market share next year?
ANSWER: It would likely overestimate its market share because the competition should increase as
competitors penetrate the European countries.
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Multinational Financial Management: An Overview 6
19. Valuation of an MNC. Birm Co., based in Alabama, is considering several international opportunities
in Europe that could affect the value of its firm. The valuation of its firm is dependent on four factors:
(1) expected cash flows in dollars, (2) expected cash flows in euros that are ultimately converted into
dollars, (3) the rate at which it can convert euros to dollars, and (4) Birm’s weighted average cost of
capital. For each opportunity, identify the factors that would be affected.
a. Birm plans a licensing deal in which it will sell technology to a firm in Germany for $3,000,000;
the payment is invoiced in dollars, and this project has the same risk level as its existing
businesses.
b. Birm plans to acquire a large firm in Portugal that is riskier than its existing businesses.
c. Birm plans to discontinue its relationship with a U.S. supplier so that can import a small amount
of supplies (denominated in euros) at a lower cost from a Belgian supplier.
d. Birm plans to export a small amount of materials to Ireland that are denominated in euros.
ANSWER:
Opportunity Dollar CF Euro CF
Exchange rate at
which Birm Co.
converts euros to
dollars
Birm’s weighted
average cost of
capital
a. joint venture X
20. Assessing Motives for International Business. Fort Worth Inc. specializes in manufacturing some
basic parts for sports utility vehicles that are produced and sold in the U.S. Its main advantage in the
U.S. is that its production is efficient, and less costly than that of some other unionized
manufacturers. It has a substantial market share in the U.S. Its manufacturing process is
labor-intensive. The company pays relatively low wages compared to U.S. competitors, but it has
guaranteed the local workers that their positions will not be eliminated for the next 30 years. It hired
a consultant to determine whether it should set up a subsidiary in Mexico, where the parts would be
produced. The consultant suggested that Forth Worth expand for the following reasons. Offer your
opinion on whether the consultant’s reasons are logical:
a. Theory of Competitive Advantage: There are not many SUVs sold in Mexico; hence, Fort Worth
Inc. would not face much competition there.
b. Imperfect Markets Theory: Fort Worth Inc. can not easily transfer workers to Mexico, but it can
establish a subsidiary there in order to penetrate a new market.
c. Product Cycle Theory: Fort Worth Inc. has been successful in the U.S. It has limited growth
opportunities because it already controls much of the U.S. market for the parts it produces. Thus,
the natural next step is to conduct the same business in a foreign country.
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Multinational Financial Management: An Overview 7
d. Exchange Rate Risk. The exchange rate of the peso has weakened recently, so this would allow
Fort Worth Inc. to build a plant at a very low cost (by exchanging dollars for the cheap pesos to
build the plant).
e. Political Risk. The political conditions in Mexico have stabilized in the last few months, so Fort
Worth should attempt to penetrate the Mexican market now.
ANSWER: None of the arguments by the consultant are logical. If SUVs are not sold in the Mexican
market, there is no need for these parts in Mexico. Fort Worth Inc. should only attempt to penetrate a
21. Valuation of Wal-Mart’s International Business. In addition to all of its stores in the United States,
Walmart Inc., Stores has 13 stores in Argentina, 302 stores in Brazil, 289 stores in Canada, 73 stores
in China, 889 stores in Mexico, and 335 stores in the United Kingdom. Overall, it has 2,750 stores in
foreign countries. Consider the value of Walmart as being composed of two parts, a U.S. part (due to
business in the United States) and a non-U.S. part (due to business in other countries). Explain how to
determine the present value (in dollars) of the non-U.S. part assuming that you had access to all the
details of Walmart businesses outside the United States.
ANSWER: The non-U.S. part can be measured as the present value of future dollar cash flows
resulting from the non-U.S. businesses. Based on recent earnings data for each store and applying an
22. Impact of International Business on Cash Flows and Risk. Nantucket Travel Agency specializes in
tours for American tourists. Until recently, all of its business was in the U.S. It just established a
subsidiary in Athens, Greece, which provides tour services in the Greek islands for American tourists.
It rented a shop near the port of Athens. It also hired residents of Athens, who could speak English
and provide tours of the Greek islands. The subsidiary’s main costs are rent and salaries for its
employees and the lease of a few large boats in Athens that it uses for tours. American tourists pay for
the entire tour in dollars at Nantucket’s main U.S. office before they depart for Greece.
a. Explain why Nantucket may be able to effectively capitalize on international opportunities such
as the Greek island tours.
ANSWER: It already has established credibility with American tourists, but could penetrate a new
b. Nantucket is privately-owned by owners who reside in the U.S. and work in the main office.
Explain possible agency problems associated with the creation of a subsidiary in Athens, Greece.
How can Nantucket attempt to reduce these agency costs?
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Multinational Financial Management: An Overview 8
ANSWER: The employees of the subsidiary in Athens are not owners, and may have no incentive to
manage in a manner that maximizes the wealth of the owners. Thus, they may manage the tours
inefficiently.
c. Greece’s cost of labor and rent are relatively low. Explain why this information is relevant to
Nantucket’s decision to establish a tour business in Greece.
ANSWER: The low cost of rent and labor will be beneficial to Nantucket, because it enables
d. Explain how the cash flow situation of the Greek tour business exposes Nantucket to exchange
rate risk. Is Nantucket favorably or unfavorably affected when the euro (Greece’s currency)
appreciates against the dollar? Explain.
ANSWER: Nantucket’s tour business in Greece results in dollar cash inflows and euro cash outflows.
e. Nantucket plans to finance its Greek tour business. Its subsidiary could obtain loans in euros from
a bank in Greece to cover its rent, and its main office could pay off the loans over time.
Alternatively, its main office could borrow dollars and would periodically convert dollars to euros
to pay the expenses in Greece. Does either type of loan reduce the exposure of Nantucket to
exchange rate risk? Explain.
ANSWER: No. The euro loans would be used to cover euro expenses, but Nantucket would need
f. Explain how the Greek island tour business could expose Nantucket to country risk.
ANSWER: The subsidiary could be subject to government restrictions or taxes in Greece that would
23. Valuation of an MNC. Yahoo! has expanded its business by establishing portals in numerous
countries, including Argentina, Australia, China, Germany, Ireland, Japan, and the U.K. It has cash
outflows associated with the creation and administration of each portal. It also generates cash inflows
from selling advertising space on its website. Each portal results in cash flows in a different currency.
Thus, the valuation of Yahoo! is based on its expected future net cash flows in Argentine pesos after
converting them into U.S. dollars, its expected net cash flows in Australian dollars after converting
them into U.S. dollars, and so on. Explain how and why the valuation of Yahoo! would change if most
investors suddenly expected that that the dollar would weaken against most currencies over time.
ANSWER: The valuation of Yahoo! should increase because the present value of expected dollar
24. Uncertainty Surrounding an MNC’s Valuation. Carlisle Co. is a U.S. firm that is about to
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Multinational Financial Management: An Overview 9
purchase a large company in Switzerland for $20 million. This company produces furniture and sells
it locally (in Switzerland), and it is expected to earn large profits every year. The company will
become a subsidiary of Carlisle and will periodically remit the excess cash flows from to its profits to
Carlisle Co. Assume that Carlisle Co. has no other international business. Carlisle has $10 million that
it will use to pay for part of the Swiss company and will finance the rest of its purchase with
borrowed dollars. Carlisle Co. can obtain supplies from either a U.S. supplier or a Swiss supplier (in
which case the payment would be made in Swiss francs). Both suppliers are reputable and there
would be no exposure to country risk when using one supplier. Is the valuation of the total cash flows
of Carlisle Co. more uncertain if it obtains its supplies from a U.S. firm or a Swiss firm? Explain
briefly.
ANSWER: The valuation of Carlisle Co. is more uncertain if it uses a U.S. supplier because it will
have a larger amount of cash flows that will be remitted from Switzerland and converted into dollars.
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