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International Corporate Governance and Control 1
POINT/COUNTER-POINT:
Can a Foreign Target Be Assessed Like Any Other Asset?
POINT: Yes. The value of a foreign target to an MNC is the present value of the future cash flows to the
MNC. The process of estimating a foreign target’s value is the same as the process of estimating a
machine’s value. A target has expected cash flows, which can be derived from information about previous
cash flows.
COUNTER-POINT: No. A target’s behavior will change after it is acquired by an MNC. Its efficiency may
change depending on the ability of the MNC to integrate the target with its own operations. The morale of
the target employees could either improve or worsen after the acquisition, depending on the treatment by the
acquirer. Thus, a proper estimate of cash flows generated by the target must consider the changes in the
target due to the acquisition.
WHO IS CORRECT? Use the Internet to learn more about this issue. Which argument do you support?
Offer your own opinion on this issue.
ANSWER: Some targets may continue their business in the same manner as before, and their cash flows
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?
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?
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?
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International Corporate Governance and Control 2
4. Valuation of a Private Target. Rastell, Inc., a U.S.-based MNC, is considering the acquisition of
a Russian target to produce tablet computers and market them throughout Russia, where demand for
tablets 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?
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, Inc.,
wants to increase its market share in the tablet computer market by acquiring a target in Thailand that
currently produces radios and converting the operations to produce tablests. 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?
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
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.
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International Corporate Governance and Control 3
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.
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.
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International Corporate Governance and Control 4
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
Cost of Goods Sold MYR100 MYR108 MYR116.6
Gross Profit MYR100 MYR108 MYR116.7
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
million shares outstanding are worth MYR270 million. At the prevailing exchange rate of $.25, the
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
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International Corporate Governance and Control 5
9. Divestiture Strategy. A crisis in a foreign country will commonly cause a substantial reduction in
cash flows (and valuations) of an MNC’s subsidiaries based in that country. Explain why the MNC
will not necessarily sell its subsidiaries even if these subsidiaries are not profitable.
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.
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?
ANSWER:
Year 0 1 2
Operating CF 525.00 551.25
Sale of Estoya 1,200.00
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
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International Corporate Governance and Control 6
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
13. Divestiture Decision. Colorado Springs Co. plans to divest either its Singapore or its Canadian
subsidiary. Assume that if exchange rates remain constant, the dollar cash flows each of these
subsidiaries would provide to the parent over time would be somewhat similar. However, the company
expects the Singapore dollar to depreciate against the U.S. dollar, and the Canadian dollar to appreciate
against the U.S. dollar. The firm can sell either subsidiary for about the same price today. Which one
should it sell?
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.
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
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International Corporate Governance and Control 7
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.]
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
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
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International Corporate Governance and Control 8
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
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
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International Corporate Governance and Control 9
Additional Cashflows from
Acquiring Perez $1,000,000 $1,000,000 $1,000,000
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:
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
Rate $1.20 $1.20
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International Corporate Governance and Control 10
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
same as Currency D’s interest
rate
Spot 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
22. Factors that Affect the NPV of a Divestiture. Clemson Co. (a U.S. firm) has a subsidiary in Germany
that generates substantial earnings in euros each year. One week ago, it received an offer from a
company to purchase it, and it has not yet responded to this offer.
a. Since last week, the expected stream of euro cash flows has not changed, but the forecasts of the
euro’s value in future periods have been revised downward. Will the NPV of the divestiture be
larger or smaller or the same as it was last week? Briefly explain.
b. Since last week, the expected stream of euro cash flows has not changed, but the long-term interest
rate in the U.S. has declined. Will the NPV of the divestiture be larger or smaller or the same as it
was last week? Briefly explain.
ANSWER:
a. Larger because what firm gives up is reduced.
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International Corporate Governance and Control 11
b. Smaller, because the PV of what firm gives up is increased.
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