978-1133947837 Chapter 13 Solution Manual

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Answers to End of Chapter Questions

1. Motives for DFI. Describe some potential benefits to an MNC as a result of direct foreign

investment (DFI). Elaborate on each type of benefit. Which motives for DFI do you think

encouraged Nike to expand its footwear production in Latin America?

ANSWER: See the text exhibit in this chapter for a complete summary of the potential benefits.

Regarding Nike’s motives, Latin America offers additional sources of demand, as Latin American

consumers have shown an interest in Nike footwear (this is partially due to increased marketing

2. Impact of a Weak Currency on Feasibility of DFI. Packer, Inc., a U.S. producer of computer disks,

plans to establish a subsidiary in Mexico in order to penetrate the Mexican market. Packer’s

executives believe that the Mexican peso’s value is relatively strong and will weaken against the

dollar over time. If their expectations about the peso value are correct, how will this affect the

feasibility of the project? Explain.

ANSWER: If the peso’s value is relatively strong now, Packer Inc. will incur high costs of

establishing a Mexican subsidiary. In addition, if the peso weakens, future remitted earnings by the

3. DFI to Achieve Economies of Scale. Bear Co. and Viking, Inc., are automobile manufacturers that

desire to benefit from economies of scale. Bear Co. has decided to establish distributorship

subsidiaries in various countries, while Viking, Inc., has decided to establish manufacturing

subsidiaries in various countries. Which firm is more likely to benefit from economies of scale?

ANSWER: Bear Company is likely to benefit because it is maintaining all of its manufacturing in

4. DFI to Reduce Cash Flow Volatility. Raider Chemical Co. and Ram, Inc., had similar intentions to

reduce the volatility of their cash flows. Raider implemented a long-range plan to establish 40

percent of its business in Canada. Ram, Inc., implemented a long-range plan to establish 30 percent

of its business in Europe and Asia, scattered among 12 different countries. Which company will more

effectively reduce cash flow volatility once the plans are achieved?

ANSWER: Ram Inc. would likely be more effective because its international business is spread

5. Impact of Import Restrictions. If the United States imposed long-term restrictions on imports,

would the amount of DFI by non-U.S. MNCs in the United States increase, decrease, or be

unchanged? Explain.

permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

Direct Foreign Investment  2

ANSWER: It would likely increase because the foreign firms would need to replace their exporting

6. Capitalizing on Low-Cost Labor. Some MNCs establish a manufacturing facility where there is a

relatively low cost of labor, but they sometimes close the facility later because the cost advantage

dissipates. Why do you think the relative cost advantage of these countries is reduced over time?

(Ignore possible exchange rate effects.)

ANSWER: As MNCs capitalize on low cost labor, they may create a strong demand for labor, which

7. Opportunities in Less Developed Countries. Offer your opinion on why economies of some less

developed countries with strict restrictions on international trade and DFI are somewhat independent

from economies of other countries. Why would MNCs desire to enter such countries? If these

countries relaxed their restrictions, would their economies continue to be independent of other

economies? Explain.

ANSWER: Countries that are unrelated to other economies are desirable because business in these

countries would not be subject to existing business cycles in other countries. Consequently, an

MNC’s overall cash flow may be more stable. However, a typical reason why these countries’

economies are independent of other economies is government restrictions on international trade and

8. Effects of September 11. In August 2001, Ohio Inc. considered establishing a manufacturing plant

in central Asia, which would be used to cover its exports to Japan and Hong Kong. The cost of labor

was very low in central Asia. On September 11, 2001, the terrorist attacks on the U.S. caused Ohio to

reassess the potential cost savings. Why would the estimated expenses of the plant increase after the

terrorist attacks?

ANSWER: The plant would be more exposed to the threat of a terrorist attack, because of increased

9. DFI Strategy. Bronco Corp. has decided to establish a subsidiary in Taiwan that will produce stereos

and sell them there. It expects that its cost of producing these stereos will be one-third the cost of

producing them in the United States. Assuming that its production cost estimates are accurate, is

Bronco’s strategy sensible? Explain.

ANSWER: No. Bronco Corporation recognized an advantage of producing stereos in Taiwan versus

the U.S. Yet, this is only an advantage if Bronco sells the stereos produced in Taiwan to the U.S.

10. Risk Resulting from International Business. This chapter concentrates on possible benefits to a

firm that increases its international business.

a. What are some risks of international business that may not exist for local business?

permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

Direct Foreign Investment  3

ANSWER: Some of the more common risks of DFI are a government takeover and changing tax

b. What does this chapter reveal about the relationship between an MNC’s degree of international

business and its risk?

ANSWER: Firms with more international business can reduce risk with diversification. Thus, firms

could reduce their risk by increasing their degree of international business. However, there are some

11. Motives for DFI. Starter Corp. of New Haven, Connecticut, produces sportswear that is licensed by

professional sports teams. It recently decided to expand in Europe. What are the potential benefits

for this firm from using DFI?

ANSWER: The primary reason would be to attract new sources of demand. This type of sportswear

12. Disney’s DFI Motives. What potential benefits do you think were most important in the decision of

the Walt Disney Co. to build a theme park in France?

ANSWER: There is no simple answer to this question, but the question usually leads to an interesting

a. New sources of demand—another theme park in the U.S. would have less potential, since U.S.

b. Economies of scale should result from the new theme park, because much of the costs associated

c. French labor may not necessarily be less costly than U.S. labor, but there may be a cost advantage

d. Exploit monopolistic advantages—there are other theme parks in Europe. Yet, some tourists may

e. Diversification—the Disney theme parks in the U.S. have experienced reduced sales when the

13. DFI Strategy. Once an MNC establishes a subsidiary, DFI remains an ongoing decision. What does

this statement mean?

permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

Direct Foreign Investment  4

ANSWER: The subsidiary established due to DFI will generate earnings that are to be either

14. Host Government Incentives for DFI. Why would foreign governments provide MNCs with

incentives to undertake DFI there?

Advanced Questions

15. DFI Strategy. JCPenney has recognized numerous opportunities to expand in foreign countries and

has assessed many foreign markets, including Brazil, Greece, Mexico, Portugal, Singapore, and

Thailand. It has opened new stores in Europe, Asia, and Latin America. In each case, the firm was

aware that it did not have sufficient understanding of the culture of each country that it had targeted.

Consequently, it engaged in joint ventures with local partners who knew the preference of the local

customers.

a. What comparative advantage does JCPenney have when establishing a store in a foreign country,

relative to an independent variety store?

ANSWER: JCPenney has name recognition, which could result in customer trust, and therefore a

b. Why might the overall risk of JCPenney decrease or increase as a result of its recent global

expansion?

ANSWER: Its risk may decrease because it has a strategy that allows it to utilize its expertise, while

Its risk could have increased if it selected local partners in the foreign countries that do not properly

c. JCPenney has been more cautious about entering China. Explain the potential obstacles

associated with entering China.

16. DFI Location Decision. Decko Co. is a U.S. firm with a Chinese subsidiary that produces cell phones

in China and sells them in Japan. This subsidiary pays its wages and its rent in Chinese yuan, which is

stable against the dollar. The cell phones sold to Japan are denominated in Japanese yen. Assume that

permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

Direct Foreign Investment  5

Decko Co. expects that the Chinese yuan will continue to stay stable against the dollar. The

subsidiary’s main goal is to generate profits for itself and it reinvests the profits. It does not plan to

remit any funds to Decko, the U.S. parent.

a. Assume that the Japanese yen strengthens against the U.S. dollar over time. How would this be

expected to affect the profits earned by the Chinese subsidiary?

b. If Decko Co. had established its subsidiary in Tokyo, Japan instead of in China, would the

subsidiary’s profits be more exposed or less exposed to exchange rate risk?

c. Why do you think that Decko Co. established the subsidiary in China instead of Japan? Assume

no major country risk barriers.

d. If the Chinese subsidiary needs to borrow money to finance its expansion and wants to reduce its

exchange rate risk, should it borrow U.S. dollars, Chinese yuan, or Japanese yen?

ANSWER:

a. If the yen appreciates against the dollar, it appreciates against the yuan (assuming the yuan is

b. If the subsidiary was established in Tokyo, Japan, it would be less exposed to exchange rate risk.

17. MNC’s Investment Decision. Trak Co. (of the U.S.) presently serves as a distributor of products by

purchasing them from other U.S. firms and selling them in Japan. It wants to purchase a manufacturer

in India that could produce similar products at a low cost (due to low labor costs in India) and export

the products to Japan. The operating expenses would be denominated in Indian rupees. The products

would be invoiced in Japanese yen. If Trak Co. can acquire a manufacturer, it will discontinue its

existing distributor business. If the yen is expected to appreciate against the dollar, and the rupee is

expected to depreciate against the dollar, how would this affect Trak’s direct foreign investment?

ANSWER: Trak Co. would benefit if the rupee depreciates over time because it will need fewer

18. MNC’s Investment Strategy. Myzo Co. (based in the U.S.) sells basic household products that

many other U.S. firms produce at the same quality level and these other U.S. firms have about the

same production cost as Myzo. Myzo is considering direct foreign investment. It believes that the

market in the U.S. is saturated and wants to pursue business in a foreign market where it can generate

more revenue. It decides to create a subsidiary in Mexico that will produce household products and

sell its products only in Mexico. This subsidiary would definitely not export its products to the U.S.

because exports to the U.S. could reduce the parent’s market share and Myzo wants to ensure that its

U.S. employees remain employed. The labor costs in Mexico are very low. Myzo will comply with

some international labor laws. By complying with the laws, the total costs of Myzo’s subsidiary will

be 20 percent higher than other Mexican producers of household products in Mexico that are of

similar quality. However, Myzo’s subsidiary will be able to produce household products at a cost that

is 40 percent lower than its cost of producing household products in the U.S. Briefly explain whether

you think Myzo’s strategy for direct foreign investment is feasible.

ANSWER: The difference in costs against local manufacturers in Mexico will be a disadvantage to

generate market acceptation there. Consumers will prefer to buy from the other manufacturers. Myzo

permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

Direct Foreign Investment  6

Solution to Continuing Case Problem: Blades, Inc.

1. Identify and discuss some of the benefits that Blades, Inc., could obtain from DFI.

ANSWER: First, since Blades’ growth potential in the United States is limited, it could utilize

2. Do you think Blades should wait until next year to undertake DFI in Thailand? What is the tradeoff if

Blades undertakes the DFI now?

ANSWER: If Blades undertakes the direct foreign investment now, the initial outlay required will be

relatively low due to the recent economic conditions in Thailand and due to the depreciation of the

baht. However, if economic conditions do not improve within the next year, Blades may not generate

3. Do you think Blades should renew its agreement with the Thai retailer for another three years? What

is the tradeoff if Blades renews the agreement?

ANSWER: If Blades renews the agreement with the Thai retailer, it will have to maintain the

relatively low prices it charges the Thai retailer. It may be able to charge higher prices by establishing

4. Assume a high level of unemployment in Thailand and a unique production process employed by

Blades, Inc. How do you think the Thai government would view the establishment of a subsidiary in

Thailand by firms such as Blades? Do you think the Thai government would be more or less

supportive if firms such as Blades acquired existing businesses in Thailand? Why?

ANSWER: Given a high level of unemployment in Thailand and a unique production process

permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

Direct Foreign Investment  7

Conversely, if a firm such as Blades acquires an existing business in Thailand, the level of

unemployment in Thailand may be reduced if the firm employs local labor. Furthermore, if the Thai

Solution to Supplemental Case: Blues Corporation

Some possible answers are provided below, although there is no perfect solution to the issues introduced.

The main objective of this case is to stimulate discussion and force students to create their own concerns

about entering Eastern Europe. Students must learn that some ventures could easily backfire.

a. Blues Corporation should not immediately jump at the opportunity unless it considers the following

b. While the competition appears overpriced, Blues Corp. must consider how that may change in the

c. Blues Corp. should not forgo its established U.S. business as a means of pursuing business in East

Small Business Dilemma

Direct Foreign Investment Decision by the Sports Exports Company

1. Given the information provided here, what are the advantages to Logan of establishing the firm in the

United Kingdom?

ANSWER: One advantage is that most of the expenses of the firm would be denominated in the

same currency (pounds) as the currency that is received when selling the goods. A second advantage

Direct Foreign Investment  8

possible advantage is that the firm would avoid any potential trade restrictions by producing the

goods in the country where they are to be sold.

2. Given the specific information provided here, what are the disadvantages to Logan of establishing the

firm in the United Kingdom?

ANSWER: One disadvantage is that Jim would incur new expenses associated with establishing a

firm in the United Kingdom. He presently uses his garage and a warehouse to produce and store

permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.