978-1133947837 Chapter 15 Solution Manual Part 1

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International Corporate Governance and Control  1

Answers to End of Chapter Questions

1. Motives for Restructuring. Why do you think MNCs continuously assess possible forms of

multinational restructuring, such as foreign acquisitions or downsizing of a foreign subsidiary?

ANSWER: MNCs continuously assess possible forms of multinational restructuring so that they can

2. Exposure to Country Regulations. Maude Inc., a U.S.-based MNC, has recently acquired a firm in

Singapore. To eliminate inefficiencies, Maude downsized the target substantially, eliminating

two-thirds of the workforce. Why might this action affect the regulations imposed on the subsidiary’s

business by the Singapore government?

ANSWER: One of the benefits of direct foreign investment from a host government’s viewpoint is the

3. Global Expansion Strategy. Poki Inc., a U.S.-based MNC, is considering expanding into Thailand

because of decreasing profit margins in the U.S. The demand for Poki’s product in Thailand is very

strong. However, forecasts indicate that the baht is expected to depreciate substantially over the next

three years. Should Poki expand into Thailand? What factors may affect its decision?

ANSWER: Poki faces a tradeoff. Demand for its product in Thailand is very strong, while it is

4. Valuation of a Private Target. Rastell, Inc., a U.S.-based MNC, is considering the acquisition of

a Russian target to produce personal computers (PCs) and market them throughout Russia, where

demand for PCs has increased substantially in recent years. Assume that the stock prices of most

Russian companies rose substantially just prior to Rastell’s assessment of the target. If Rastell Inc.

acquires a private target in Russia, will it be able to avoid the impact of the high stock prices on

business valuations in Russia?

ANSWER: No. If stock prices of public companies rise, stock price multiples of public companies

5. Comparing International Projects. Savannah, Inc., a manufacturer of clothing, wants to increase its

market share by acquiring a target producing a popular clothing line in Europe. This clothing line is

well established. Forecasts indicate a relatively stable euro over the life of the project. Marquette,

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International Corporate Governance and Control  2

Inc., wants to increase its market share in the personal computer market by acquiring a target in

Thailand that currently produces radios and converting the operations to produce PCs. Forecasts

indicate a depreciation of the baht over the life of the project. Funds resulting from both projects will

be remitted to the respective U.S. parent on a regular basis. Which target do you think will result in a

higher net present value? Why?

ANSWER: The European target will likely result in a higher NPV. First, the euro has generally been

6. Privatized Business Valuations. Why are valuations of privatized businesses previously owned by

the governments of developing countries more difficult than valuations of existing firms in developed

countries?

ANSWER: There are several reasons why the valuation of a privatized business may be more difficult

than the valuation of an existing firm in a developed country. First, future cash flows associated with

a privatized business are very uncertain because the businesses previously have been operating in

7. Valuing a Foreign Target. Blore Inc., a U.S.-based MNC, has screened several targets. Based on

economic and political considerations, only one eligible target remains in Malaysia. Blore would like

you to value this target and has provided you with the following information:

Blore expects to keep the target for three years, at which time it expects to sell the firm for 300

million Malaysian ringgit (MYR) after any taxes.

Blore expects a strong Malaysian economy. The estimates for revenue for the next year are

MYR200 million. Revenues are expected to increase by 8% in each of the following two years.

Cost of goods sold is expected to be 50% of revenue.

Selling and administrative expenses are expected to be MYR30 million in each of the next three

years.

The Malaysian tax rate on the target’s earnings is expected to be 35 percent.

Depreciation expenses are expected to be MYR20 million per year for each of the next three

years.

The target will need MYR7 million in cash each year to support existing operations.

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International Corporate Governance and Control  3

The target’s stock price is currently MYR30 per share. The target has 9 million shares

outstanding.

Any remaining cash flows will be remitted by the target to Blore Inc. Blore uses the prevailing

exchange rate of the Malaysian ringgit as the expected exchange rate for the next three years. This

exchange rate is currently $.25.

Blore’s required rate of return on similar projects is 20 percent.

a. Prepare a worksheet to estimate the value of the Malaysian target based on the information

provided.

ANSWER:

Valuation of Malaysian Target Based on the Assumptions Provided

(numbers are in millions)

Year 1 Year 2 Year 3

Revenue MYR200 MYR216 MYR233.3

The value of the Malaysian target based on the information provided is $69.9 million.

b. Will Blore Inc. be able to acquire the Malaysian target for a price lower than its valuation of

the target?

ANSWER: The Malaysian target’s shares are presently valued at MYR30 per share. Thus, the 9

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International Corporate Governance and Control  4

8. Uncertainty Surrounding a Foreign Target. Refer to question 7. What are some of the key sources

of uncertainty in Blore’s valuation of the target? Identify two reasons why the expected cash flows

from an Asian subsidiary of a U.S.-based MNC would be lower as if Asia experienced a new crisis.

ANSWER: There is much uncertainty regarding the assumptions employed. For example, the growth

rate in revenues may be overestimated if Blore has overestimated the growth rate of the Malaysian

9. Divestiture Strategy. The reduction in expected cash flows of Asian subsidiaries as a result of the

Asian crisis likely resulted in a reduced valuation of these subsidiaries from the parent’s perspective.

Explain why a U.S.-based MNC might not have sold its Asian subsidiaries.

ANSWER: The valuation of the subsidiaries would have declined because of the reduction in cash

flows, so potential buyers may not have been willing to pay an amount that even reflects the present

10. Why a Foreign Acquisition May Backfire. Provide two reasons why an MNC’s strategy of acquiring

a foreign target will backfire. That is, explain why the acquisition might result in a negative NPV.

ANSWER: The MNC may overestimate the cash flows to be generated by the target, due to

Advanced Questions

11. Pricing a Foreign Target. Alaska Inc. would like to acquire Estoya Corp., which is located in Peru.

In initial negotiations, Estoya has asked for a purchase price of 1 billion Peruvian new sol. If Alaska

completes the purchase, it would keep Estoya’s operations for two years and then sell the company. In

the recent past, Estoya has generated annual cash flows of 500 million new sol per year, but Alaska

believes that it can increase these cash flows 5 percent each year by improving the operations of the

plant. Given these improvements, Alaska believes it will be able to resell Estoya in two years for 1.2

billion new sol. The current exchange rate of the new sol is $.29, and exchange rate forecasts for the

next two years indicate values of $.29 and $.27, respectively. Given these facts, should Alaska Inc.

pay 1 billion new sol for Estoya Corp. if the required rate of return is 18 percent? What is the

maximum price Alaska should be willing to pay?

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International Corporate Governance and Control  5

ANSWER:

Year 0 1 2

Operating CF 525.00 551.25

Sale of Estoya 1,200.00

Alaska, Inc. should not pay more than $468.62 million for Estoya Corp. Estoya is asking for 1.2

12. Global Strategy. Senser Co. established a subsidiary in Russia two years ago. Under its original

plans, Senser intended to operate the subsidiary for a total of four years. However, it would like to

reassess the situation, since exchange rate forecasts for the Russian ruble indicate that it may

depreciate from its current level of $.033 to $.028 next year and to $.025 in the following year. Senser

could sell the subsidiary today for 5 million rubles to a potential acquirer. If Senser continues to

operate the subsidiary, it will generate cash flows of 3 million rubles next year and 4 million rubles in

the following year. These cash flows would be remitted back to the parent in the U.S. The required

rate of return of the project is 16 percent. Should Senser continue operating the Russian subsidiary?

ANSWER:

End of Year 2 End of Year 3 End of Year 4

Rubles remitted 3,000,000 4,000,000

Selling price 5,000,000

International Corporate Governance and Control  6

14. Divestiture Decision. San Gabriel Corp. recently considered divesting its Italian subsidiary and

determined that the divestiture was not feasible. The required rate of return on this subsidiary was 17

percent. In the last week, San Gabriel’s required return on that subsidiary increased to 21 percent. If

the sales price of the subsidiary has not changed, explain why the divestiture may now be feasible.

ANSWER: As a project’s required rate of return increases, the present value of cash flows decreases.

15. Divestiture Decision. Ethridge Co. of Atlanta, Georgia has a subsidiary in India that produces

products and sells them throughout Asia. In response to the September 11, 2001 terrorist attack on the

U.S., Ethridge Co. decided to conduct a capital budgeting analysis to determine whether it should

divest the subsidiary. Why might this decision be different after the attack as opposed to before the

attack? Describe the general method for determining whether the divestiture is financially feasible.

ANSWER: The divestiture decision may be different because cash flow estimates may have changed

16. Feasibility of a Divestiture. Merton Inc. has a subsidiary in Bulgaria that it fully finances with its

own equity. Last week, a firm offered to buy the subsidiary from Merton Inc. for $60 million in cash

and the offer is still available this week as well. The annualized long-term risk-free rate in the U.S.

increased from 7% to 8% this week. The expected monthly cash flows to be generated by the

subsidiary have not changed since last week. The risk premium that Merton Inc. applies to its projects

in Bulgaria was reduced from 11.3% to 10.9% this week. The annualized long-term risk-free rate in

Bulgaria declined from 23% to 21% this week. Would the NPV to Merton Inc. from divesting this

unit be more or less than the NPV determined last week? Why? [No analysis is necessary, but make

sure that your explanation is very clear.]

ANSWER: The NPV of the divestiture would be higher because a higher discount rate would be used

as the required rate of return applied to the subsidiary’s cash flows. The risk-free rate increased by 1%

17. Accounting for Government Restrictions. Sunbelt Inc. plans to purchase a firm in Indonesia. It

believes that it can install its operating procedure in this firm, which would significantly reduce the

firm’s operating expenses. However, the Indonesian government may approve the acquisition only if

Sunbelt does not lay off any workers. How can Sunbelt possibly increase efficiency without laying off

workers? How can Sunbelt account for the Indonesian government’s position as it assesses the NPV

of this possible acquisition?

ANSWER: Sunbelt should first consider the profile of the workers who it would lay off if it could

after improving the operations. Then, it could decide how it could revise the job descriptions so that

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International Corporate Governance and Control  7

18. Foreign Acquisition Decision. Florida Co. produces software. Its primary business in Boca

Raton is expected to generate cash flows of $4,000,000 at the end of each of the next 3 years, and

expects that it could sell this business for $10 million (after accounting for capital gains taxes) at the

end of 3 years. Florida Co. also has a side business in Pompano Beach that takes the software created

in Boca Raton and exports it to Europe. As long as the side business distributes this software to

Europe, it is expected to generate $2 million in cash flows at the end of each of the next three years.

This side business in Pompano Beach is separate from Florida’s main business.

Recently, Florida was contacted by a Ryne Co. in Europe which specializes in distributing software

throughout Europe. If Florida acquires Ryne Co., it would rely on Ryne instead of its side business to

sell its software in Europe, because Ryne could easily reach all of Florida Company’s existing

European customers and additional potential European customers. By acquiring Ryne, Florida would

be able to sell much more software in Europe than it can sell with its side business, but it has to

determine whether the acquisition would be feasible. The initial investment to acquire Ryne Co.

would be $7 million. Ryne would generate 6 million euros per year in profits, and would be subject to

a European tax rate of 40%. All after-tax profits would be remitted to Florida Co. at the end of each

year and the profits would not be subject to any U.S taxes since they were already taxed in Europe.

The spot rate of the euro is $1.10 and Florida Co. believes the spot rate is a reasonable forecast of

future exchange rates. Florida Co. expects that it could sell Ryne Co. at the end of 3 years for 3

million euros (after accounting for any capital gains taxes). Florida Company’s required rate of return

on the acquisition is 20%. Determine the net present value of this acquisition. Should Florida Co.

acquire Ryne Co.?

ANSWER:

Year 0 Year 1 Year 2 Year 3

Profit €6,000,000 €6,000,000 €6,000,000

After tax (40%) €3,600,000 €3,600,000 €3,600,000

Sale of Company €3,000,000

Rate $1.10 $1.10 $1.10

PV (20% discount

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International Corporate Governance and Control  8

– $961,574

19. Foreign Acquisition Decision. Minnesota Company consists of two businesses. Its local business

is expected to generate cash flows of $1,000,000 at the end of each of the next 3 years. It also owns a

foreign subsidiary based in Mexico, whose business is selling technology in Mexico. This business is

expected to generate $2,000,000 in cash flows at the end of each of the next three years. The main

competitor of the Mexican subsidiary is Perez Co., a privately-held firm that is based in Mexico.

Minnesota Company just contacted Perez Co., and wants to acquire it. If it acquires Perez, Minnesota

would merge the operations of Perez Co. with its Mexican subsidiary’s business. It expects that these

merged operations in Mexico would generate a total of $3,000,000 in cash flows at the end of each of

the next 3 years. Perez Co. is willing to be acquired for a price of 40 million pesos. The spot rate of

the Mexican peso is $.10. The required rate of return on this project is 24%. Determine the net present

value of this acquisition by Minnesota Company. Should Minnesota Company pursue this

acquisition?

ANSWER:

Year 1 Year 2 Year 3

Additional Cashflows from

20. Decision to Sell a Business. Kentucky Co. has an existing business in Italy that it is trying to sell.

It receives one offer today from Rome Co. for $20 million (after capital gains taxes are paid).

Alternatively, Venice Co. wants to buy the business, but will not have the funds to make the

acquisition until 2 years from now. It is meeting with Kentucky Co. today to negotiate the acquisition

price that it will pay for Kentucky in two years. If Kentucky Co. retains the business for the next two

years, it expects that the business would generate 6 million euros per year in cash flows (after taxes

are paid) at the end of each of the next two years, which would be remitted to the U.S. The euro is

presently $1.20 and that rate can be used as a forecast of future spot rates. Kentucky would only

retain the business if it can earn a rate of return of at least 18% by keeping the firm for the next two

years rather than selling it to Rome Co. now. Determine the minimum price in dollars at which

Kentucky should be willing to sell its business (after accounting for capital gain taxes paid) to Venice

Co. in order to satisfy its required rate of return.

ANSWER

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International Corporate Governance and Control  9

To determine the minimum price in dollars at which Kentucky Co should be willing to sell the

business two years from now, determine the NPV of its operation for the next two years. The

calculations below show the NPV of the future cash flows is $11,272,623.

Year 1 Year 2

Cash flow in euro € 6,000,000 €6,000,000

Kentucky Co should be willing to sell its business in two years for no less than the difference between

the $20,000,000 offer today and the NPV, with an adjustment for the time value of money:

21. Foreign Divestiture Decision. Baltimore Co. considers divesting its 6 foreign projects as of

today. Each project will last one year. Its required rate of return on each project is the same. The cost

of operations for each project is denominated in dollars and is the same. Baltimore believes that each

project will generate the equivalent of $10 million in one year based on today’s exchange rate.

However, each project generates its cash flow in a different currency. Baltimore believes that interest

rate parity (IRP) exists. Baltimore forecasts exchange rates as explained in the table below.

a. Based on this information, which project will Baltimore be most likely to divest? Why?

b. Based on this information, which project will Baltimore be least likely to divest? Why?

Project

Comparison of one-year U.S.

and foreign Interest rates

Method used to forecast the

spot rate one year from now

Country A The U.S. interest rate is higher

than currency A’s interest rate

Spot rate

Country B The U.S interest rate is higher

than currency B’s interest rate

Forward rate

Country C The U.S. interest rate is the

same as currency C’s interest

rate

Forward rate

Country D The U.S. interest rate is the Spot rate

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International Corporate Governance and Control  10

same as Currency D’s interest

rate

Country E The U.S. interest rate is lower

than Currency E’s interest rate

Forward rate

Country F The U.S. interest rate is lower

than Currency F’s interest rate

Spot rate

ANSWER:

a. Baltimore will be most likely to divest the project in country E because it anticipates depreciation

b. Baltimore is least likely to divest the project in country B because it anticipates appreciation of

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