Chapter 13
Direct Foreign Investment
Lecture Outline
Motives for Direct Foreign Investment (DFI)
Revenue-Related Motives
Cost-Related Motives
Comparing Benefits of DFI Among Countries
Benefits of International Diversification
Diversification Analysis of International Projects
Host Government Impact on DFI
Incentives to Encourage DFI
Barriers to DFI
Assessing the Feasibility of Potential DFI
A Case Study of Assessing DFI
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Chapter Theme
The main purpose of this chapter is to illustrate why MNCs often use DFI and to suggest the various
factors involved in the DFI decision. The specifics involved in quantifying costs and benefits of DFI are
discussed in the following chapter. Thus, this chapter should be covered in general terms as to the costs
and benefits of DFI. The chapter implicitly suggests that each firm may benefit from DFI by capitalizing
on some unique perceived advantages of the foreign market. Yet, all DFI decisions relate to the MNC’s
overall risk and return objectives.
Topics to Stimulate Class Discussions
1. Why would a large advanced MNC consider DFI in some less developed country?
2. Assume that you produce plastic computer pieces for computer companies. The pieces require very
little technology. Where would you like to establish DFI? (The point of this question is to force
3. What factors would be considered when deciding whether a subsidiary should reinvest earnings or
remit them to the parent?
4. The DFI decision is related to marketing, finance, and management. What is the role of each area in
5. Do you think DFI is primarily intended to reduce production costs or increase sales? Discuss.
POINT/COUNTER-POINT:
Should MNCs Avoid DFI in Countries without Child Labor Laws?
POINT: Yes. An MNC should maintain its hiring standards, regardless of what country it is in. Even if a
foreign country allows children to work, an MNC should not lower its standards. Although the MNC
forgoes the use of low-cost labor, it maintains its global credibility.
COUNTER-POINT: No. An MNC will not only benefit its shareholders but will create employment for
some children who need support. The MNC can provide reasonable working conditions and perhaps may
even offer educational programs for its employees.
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: This is a well-documented controversy which generates interesting discussion. Some students
will likely support the point while others will support the counter-point. There are some obvious issues
that an MNC would need to consider, such as:
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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
2. Impact of a Weak Currency on Feasibility of DFI. Packer, Inc., a U.S. producer of tablet
computers, plans to establish a subsidiary in Mexico in an effort 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 trend affect
the feasibility of the project? Explain.
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, whereas Viking, Inc., has decided to establish manufacturing
subsidiaries in various countries. Which firm is more likely to benefit from economies of scale?
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 its cash flow volatility once its plans are achieved?
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.
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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?
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
discussion. Some of the more likely motives as related to those discussed in this chapter are:
a. New sources of demand—another theme park in the U.S. would have less potential, since U.S.
tourists are willing to travel to California or Florida to see the theme parks.
13. DFI Strategy. Once an MNC establishes a subsidiary, DFI remains an ongoing decision. What does
this statement mean?
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a. Assume that the Japanese yen strengthens against the U.S. dollar over time. How would this trend
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
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 these trends affect Trak’s direct foreign
investment?
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 approximately 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 that mean 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 DFI is feasible.
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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
will not be willing to match local prices, because its product would be sold at loss. Myzo could
reconsider restructuring the company and become more competitive in the U.S. market.
CRITICAL THINKING
Motives for Facebook’s International Expansion Facebook has expanded its business internationally,
as described by various web links (based on online search terms “Facebook” and “international
expansion”). Write a short essay to explain Facebook’s motivation for its international expansion?
Explain the possible risks of international expansion by Facebook.
ANSWER
Facebook can increase its revenue from building its customer base. It could increase its advertising
Solution to Continuing Case Problem: Blades, Inc.
1. Identify and discuss some of the benefits that Blades, Inc., could obtain from DFI.
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?
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?
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permitted in a license distributed with a certain product or service or otherwise on a password–protected website for classroom use.
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
its own distribution channels. If economic conditions in Thailand improve, demand for Blades’
products in Thailand will likely be strong, and Blades would probably generate higher profit margins
by using its own distribution channels. However, if economic conditions in Thailand continue to
deteriorate, the agreement would be an advantage for Blades, as it guarantees the sale of a minimum
number of products sold each year.
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 subsidiaries 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
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
information. First, while the labor cost is low today, it may increase over time as East and West
German economies become more integrated. Second, while the East German facility is inefficient,
the potential to remove the inefficiencies may be limited by the government. For example, the
government may require that all workers at the facility remain employed. Third, there may be much
uncertainty about the restrictions that could be enforced as conditions of ownership in East Germany,
such as high taxes and environmental restrictions. These factors must be accounted for.
b. While the competition appears overpriced, Blues Corp. must consider how that may change in the
long run. Some of the government-owned businesses may be privatized over time, which would
likely increase efficiency and reduce prices. Therefore, competition could become more intense in
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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?
2. Given the specific information provided here, what are the disadvantages to Logan of establishing the
firm in the United Kingdom?