978-1337269964 Chapter 1 Solution Manual Part 2

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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.

24. Uncertainty Surrounding an MNC’s Valuation. Carlisle Co. is a U.S. firm that is about to 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.

25. Impact of Exchange Rates on MNC Value. Olmsted Co. has small computer chips assembled in

Poland and transports the final assembled products to the parent, where they are sold by the parent in

the U.S. The assembled products are invoiced in dollars. It uses Polish currency (the zloty) to produce

these chips, and assembles them in Poland. The Polish subsidiary pays the employees in the local

currency (zloty). Olmsted Co. finances its subsidiary operations with loans from a Polish bank (in

zloty). The parent of Olmsted will send sufficient monthly payments (in dollars) to the subsidiary in

order to repay the loan and other expenses incurred by the subsidiary. If the Polish zloty depreciates

against the dollar over time, will that have a favorable, unfavorable, or neutral effect on the value of

Olmsted Co.? Briefly explain.

26. Impact of Uncertainty on MNC Value. Minneapolis Co. is a major exporter of products to Canada.

Today, an event occurred that has increased the uncertainty surrounding the Canadian dollar’s future

value over the long term. Explain how this event can affect the valuation of Minneapolis Co.

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Multinational Financial Management: An Overview  2

27. Exposure of MNCs to Exchange Rate Movements. Arlington Co. expects to receive 10 million

euros in each of the next 10 years. It will need to obtain 2 million Mexican pesos in each of the next

10 years. The euro is presently valued at $1.38 and is expected to depreciate by 2 percent each year.

The peso is valued at $.13 and is expected to depreciate by 2 percent each year. Review the valuation

equation for an MNC. Do you think that the exchange rate movements will have a favorable or

unfavorable effect on the MNC?

28. Impact of a Recession on an MNC’s Value. If a U.S. recession occurred without any change in

interest rates, identify the part of the MNC valuation equation that would likely be most affected.

29. Exposure of MNCs to Exchange Rate Movements. Because of the low labor costs in Thailand,

Melnick Co. (based in the United States) recently established a major research and development

subsidiary there. The wholly-owned subsidiary was created to improve new products that the parent

of Melnick can sell in the United States (denominated in dollars) to U.S. customers. The subsidiary

pays its local employees in baht (the Thai currency). The subsidiary has a small amount of sales

denominated in baht, but its expenses are much larger than its revenue. It has just obtained a large

baht-denominated loan that will be used to expand its subsidiary. The business that the parent of

Melnick Co. conducts in the United States is not exposed to exchange rate risk. If the Thai baht

weakens over the next 3 years, will the value of Melnick Co. be favorably affected, unfavorably

affected, or unaffected? Briefly explain.

30. Shareholder Rights of Investors in MNCs. MNCs tend to expand more when they more easily

access funds by issuing stock. In some countries, shareholder rights are very limited and so the MNCs

are less able to raise funds by issuing stock. Explain why access to funding is more severe for MNCs

based in countries where shareholder rights are limited.

31. MNC Cash Flows and Exchange Rate Risk. Tuscaloosa Co. is a U.S. firm that assembles phones in

Argentina and transports the final assembled products to the parent, which sells them in the U.S.. The

assembled products are invoiced in dollars. The Argentine subsidiary obtains some material from

China, and the Chinese exporter is willing to accept Argentine pesos as payment for these exported

materials. The Argentine subsidiary pays its employees in the local currency (pesos), and finances its

operations with loans from an Argentine bank (in pesos). Tuscaloosa Co. has no other international

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Multinational Financial Management: An Overview  3

business. If the Argentine peso depreciates against the dollar over time, will that have a favorable,

unfavorable, or neutral effect on Tuscaloosa Co.? Briefly explain.

Tuscaloosa Co. has no cash inflows in Argentine pesos, but has cash outflows in Argentine pesos.

Therefore, it benefits if the peso depreciates because it can obtain pesos with fewer dollars and can

reduce its cost.

32. MNC Cash Flows and Exchange Rate Risk. Asheville Co. has a subsidiary in Mexico that

develops software for its parent. It rents a large facility in Mexico and hires many people in Mexico to

work in the facility. Ashville Co. has no other international business. All operations are presently

funded by Asheville’s parent. All the software is sold to U.S. firms by Asheville’s parent and is

invoiced in U.S. dollars.

a. If the Mexican peso appreciates against the dollar, does this have a favorable effect, an

unfavorable effect, or no effect on Asheville’s value?

b. Asheville Co. plans to borrow funds to support its expansion in the U.S. The Mexican interest

rates are presently lower than U.S. interest rates, so Asheville obtains a loan denominated in

Mexican pesos in order to support its expansion in the U.S. Will the borrowing of pesos increase,

decrease, or have no effect on its exposure to exchange rate risk? Briefly explain.

33. Estimating an MNC’s Cash Flows. Biloxi Co. is a U.S. firm with a subsidiary in China. The

subsidiary reinvests half of its net cash flows into operations and remits half to the parent. Biloxi Co.

has expected cash flows of $10,000,000 from domestic business and the Chinese subsidiary is

expected to generate 100 million Chinese yuan at the end of the year. The expected value of yuan at

the end of the year is $.13. What are the expected dollar cash flows of the parent of Biloxi Co. in one

year?

ANSWER:

34. Uncertainty Surrounding an MNC’s Cash Flows.

a. Assume that Bangor Co. (a U.S. firm) knows that it will have cash inflows of $900,000 from

domestic operations, cash inflows of 200,000 Swiss francs resulting from exports to Swiss

operations, and cash outflows of 500,000 Swiss francs at the end of the year. Although the future

value of the Swiss franc is uncertain, your best guess is that it will be worth $1.10 at the end of

this year. What are the expected dollar cash flows of Bangor Co?

b. Assume that Concord Co. (a U.S. firm) is in the same industry as Bangor Co. There is no political

risk that could have any impact on the cash flows of either firm. Concord Co. knows that it will

have cash inflows of $900,000 from domestic operations, cash inflows of 700,000 Swiss francs

from exports to Swiss operations, and cash outflows of 800,000 Swiss francs at the end of the

year. Is the valuation of the total cash flows of Concord Co. more uncertain or less uncertain than

the total cash flows of Bangor Co.? Explain briefly.

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Multinational Financial Management: An Overview  4

ANSWER:

35. Valuation of an MNC. Odessa Co., Midland Co., and Roswell Co. are U.S. firms in the same industry

and have the same valuation as of yesterday, based on the present value of future cash flows of each

company. Odessa Co. obtains a large amount of its supplies invoiced in euros from European countries,

and all of its sales are invoiced in dollars. Midland has a large subsidiary in Europe that does all of its

business in euros and remits profits to the U.S. parent every year. Roswell Co. has no international

business. Suppose an event occurs that you believe will cause a substantial depreciation of the euro

against the dollar over time, but assume this event will not change the business operations of the firms

mentioned. Which firm will have the highest valuation based on your expectations? Briefly explain.

ANSWER

36. Impact of Uncertainty on an MNC’s Valuation. Assume that Alpine Co. is a U.S. firm that has

direct foreign investment in Brazil as a result establishing a subsidiary there. Political conditions have

changed in Brazil, but the best guess by investors regarding the future annual cash flows for Alpine

Co. has not changed despite the uncertainty surrounding those estimates. In other words, the

distribution of possible outcomes above and below the best guess has widened. Would this change in

uncertainty cause the prevailing value of Alpine Co. to increase, decrease, or remain unchanged?

Briefly explain.

37. Exposure of MNC Cash Flows.

a. Rochester Co. is a U.S. firm that has a language institute in France. This institute attracts

Americans who want to learn the French language. Rochester Co. charges tuition to the American

students in dollars. It expects that its dollar revenue from charging tuition will be stable over each

of the next several years. Rochester’s total expenses for this business project are as follows. It

rents a facility in Paris, and makes a large rent payment each month in euros. It also hires several

French citizens as full-time instructors, and pays their salary in euros. Rochester Co. expects that

its euro-denominated expenses will be stable over each of the next several years. If the euro

appreciates against the dollar over time, should this have a favorable effect, unfavorable effect, or

no effect on the value of Rochester Co.? Briefly explain.

b.Rochester considers a new project in which it would also attract people from Spain, and the

institute in France would teach them the French language; tuition would be charged in euros. The

expenses for this project would be about the same as those for the one just described for

American students. Assume that euros to be generated by this project would be stable over the

next several years. Assume that this project is about the same size as the project for American

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Multinational Financial Management: An Overview  5

students. For either project, the expected annual revenue is just slightly larger than the expected

annual expenses. Is the valuation of net cash flows subject to a higher degree of exchange rate

risk for this project or for the project for American students? Briefly explain.

CRITICAL THINKING

Impact of International Environment of MNC Cash Flows Conduct an online search to review a

recent annual report of the operations of any publicly-traded U.S.-based MNC. Write a brief essay in

which you describe how the MNC’s cash flows are exposed to the international environment. Is the MNC

you selected most exposed to a particular currency? If so, how would depreciation of that currency

against the dollar affect the value of the MNC? Is the MNC exposed to economic conditions in a

particular foreign country? If so, describe how a change in the conditions of that country could adversely

affect the MNC’s cash flows.

ANSWER

Solution to Continuing Case Problem: Blades, Inc.

1. What are the advantages Blades could gain from importing from and/or exporting to a foreign country

such as Thailand?

ANSWER: The advantages Blades, Inc. could gain from importing from Thailand include potentially

2. What are some of the disadvantages Blades could face as a result of foreign trade in the short run? In

the long run?

ANSWER: There are several potential disadvantages Blades, Inc. should consider. First of all, Blades

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Multinational Financial Management: An Overview  6

3. Which theories of international business described in this chapter apply to Blades, Inc. in the short

run? In the long run?

4. What long-range plans other than establishing a subsidiary in Thailand are possible for Blades?

Would these other options be more suitable for the company?

ANSWER: Since Ben Holt is very unfamiliar with international business, and since Blades has never

Solution to Supplemental Case: Ranger Supply Company

This case is simply intended to force students to think about reasons for or against international business.

As with most cases, there are no perfect solutions, but there are some general conclusions that can be

drawn.

a. Some of the more obvious factors to consider are:

1. Competition. There are similar distributors in Canada, whereas Eastern Europe may not have an

organized system for the distribution of office supplies. Yet, some European firms (like the

British competitor) may attempt to pursue the Eastern European market.

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Multinational Financial Management: An Overview  7

2. Transportation Costs. The costs of transporting office supplies to Eastern Europe would be high,

placing Ranger at a relative disadvantage compared to other European firms.

3. Export Barriers. Either country could impose tariffs or quotas on the exports. Canada is less

likely than Eastern European countries to impose such restrictions.

4. Marketing Characteristics. Ranger would have an easier time adapting to the Canadian market.

5. Exchange Rates. The future exchange rates of the Canadian dollar and currencies of Eastern

European countries could be relevant. Even if Ranger plans to invoice the exports in dollars, the

Overall, most of the factors would favor Canada as the more reasonable market to pursue.

b. Recall that the reason for Ranger to expand overseas was to offset the anticipated U.S. demand for its

supplies. In this way, it could maintain its present production level and avoid problems with excess

Small Business Dilemma

In every chapter of this text, some of the key concepts are illustrated with an application to a small

sporting goods firm that conducts international business. The “Small Business Dilemma” in each

chapter allows students to recognize the dilemmas and possible decisions that firms (such as this sporting

goods firm) may face in a global environment. For this chapter, the application is on the development of

the sporting goods firm that would conduct international business.

Developing a Multinational Sporting Goods Corporation

1. Is Sports Exports Company a multinational corporation?

2. Why are the agency costs lower for Sports Exports Company than for most MNCs?

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Multinational Financial Management: An Overview  8

3. Does Sports Exports Company have any comparative advantage over potential competitors in foreign

countries that could produce and sell footballs there?

4. How would Jim Logan decide which foreign markets he would attempt to enter? Should he initially

focus on one or many foreign markets?

5. The Sports Exports Company has no immediate plans to conduct direct foreign investment. However,

it might consider other less costly methods of establishing its business in foreign markets. What

methods might the Sports Exports Company use to increase its presence in foreign markets by

working with one or more foreign companies?

International Investing Project

This project is provided in Appendix D in the back of the text. It may be used as a project assignment

that is to be completed by the end of the semester.

Discussion in the Board Room

This exercise is provided in Appendix E in the back of the text. It may be used as a project

assignment that is to be completed by the end of the semester. Possible answers to the discussion

questions are provided at the end of this Instructor’s Manual (at the end of Chapter 21). If you use this

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Multinational Financial Management: An Overview  9

appendix for in-class discussion on a weekly basis, you may benefit from making a copy of the

discussion questions and possible answers provided at the end of the Instructors Manual so that you

have easy access to this exercise each week in class.

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