International Business Chapter 15 International Corporate Governance And Control Lecture Outline International Corporate Governance Governance

Chapter 15

International Corporate Governance and Control

Lecture Outline

International Corporate Governance

Governance by Board Members

Governance by Institutional Investors

Governance by Shareholder Activists

International Corporate Control

Motives for International Acquisitions

International Acquisition Process

Barriers to International Corporate Control

Model for Valuing a Foreign Target

Factors Affecting a Target Valuation

Target-Specific Factors

Country-Specific Factors

Case Study of Valuing a Foreign Target

International Screening Process

Disparity in Foreign Target Valuations

Expected Cash Flows of the Foreign Target

Exchange Rate Effects on Remitted Earnings

Required Return of Acquirer

Other Corporate Control Decisions

International Partial Acquisitions

International Acquisitions of Privatized Businesses

International Divestitures

Control Decisions as Real Options

Call Option on Real Assets

Put Option on Real Assets

International Corporate Governance and Control ❖ 2

Chapter Theme

This chapter emphasizes how an MNC can be subject to governance. The potential for corporate control

can encourage MNC managers to maximize value for their shareholders and may allow for opportunities

to expand internationally or to reduce international operations.

Topics to Stimulate Class Discussion

1. Why are MNCs subject to corporate control?

2. How should MNCs determine whether multinational restructuring is worthwhile?

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.

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?

International Corporate Governance and Control ❖ 3

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

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

potential reduction of unemployment. If a U.S.-based MNC such as Maude contributes to growing

unemployment in the host country, the government may impose special taxes or requirements that

would render further expansion in Singapore undesirable.

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

deteriorating in the U.S. However, the baht is expected to depreciate substantially, which would

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 that the euro will remain relatively stable 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 that the baht will depreciate over the life of the project. Funds resulting from both

Savannah’s and Marquette’s 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?

International Corporate Governance and Control ❖ 5

(numbers are in millions)

Year 1 Year 2 Year 3

Revenue MYR200 MYR216 MYR233.3

Tax (35%) MYR17.5 MYR20.3 MYR23.3

Earnings After Taxes MYR32.5 MYR37.7 MYR43.4

Sale of Firm MYR300

Cash Flows in MYR MYR45.5 MYR50.7 MYR356.4

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

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 economic crisis.

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

International Corporate Governance and Control ❖ 7

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

13. Divestiture Decision. Colorado Springs Co. plans to divest either its Singapore subsidiary or its

Canadian subsidiary. Assume that if exchange rates remain constant, the dollar cash flows that 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 but

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 attacks 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

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

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

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 monthly cash flows expected 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?

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 as well as even more 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.

International Corporate Governance and Control ❖ 9

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

After tax (40%)

€3,600,000

Sale of Company

€3,000,000

Rate

$1.10

Cash flow to

parent, ignoring

impact on existing

business

$3,960,000

$7,260,000

Impact on existing

business

-$2,000,000

Cash flow to

parent,

incorporating

impact on existing

business

$1,960,000

$5,260,000

PV (20% discount

rate)

$1,633,333

$1,361,111

$3,043,981

Initial Investment

-$7,000,000

Cumulative NPV

-$5,366,666

-$4,005,555

– $961,574

The acquisition will not be feasible, since it will require substantial initial investment, and will also

eliminate the cash flows of the existing business.

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 Perez’s operations with its Mexican subsidiary’s business. The merged operations in

Mexico would be expected to 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 the company pursue this acquisition?

International Corporate Governance and Control ❖ 10

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

ANSWER:

Year 1

Year 2

Year 3

Additional Cashflows from

Acquiring Perez

$1,000,000

Required Rate of Return

0.24

Present Value of CF

$806,451

$650,364

$524,487

The present value = $806,451 + $650,364 + $534,487 = $1,981,303

NPV = $1,981,303 – $4,000,000 = -$2,018,697

Minnesota should not pursue the acquisition.

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). Another

Italian company, Venice Co., also wants to buy the business, but will not have the funds to make the

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

acquisition price that it will pay for Kentucky’s subsidieary 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 valued at $1.20 and that rate can be used as a forecast of future spot

rates. Kentucky would only retain the business if it could 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 for which Kentucky should be willing to sell its business (after accounting

for capital gains 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

Cash flow to the parent

company

$7,200,000

PV of parent cash flows

(18% discount rate)

$6,101,695

$5,170,928

Cumulative NPV

$11,272,623

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:

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

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

today. Each project will last one year. The company’s 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 for all six

projects. 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 following table.

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 country A’s interest rate

Spot rate

Country B

The U.S interest rate is higher

than counntry B’s interest rate

Forward rate

Country C

The U.S. interest rate is the

same as country C’s interest

rate

Forward rate

Country D

The U.S. interest rate is the

same as country D’s interest

rate

Spot rate

Country E

The U.S. interest rate is lower

than country E’s interest rate

Forward rate

Country F

The U.S. interest rate is lower

than country F’s interest rate

Spot rate

ANSWER:

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, Clemson received an

offer from a company to purchase the German subsidiary, and it has not yet responded to this offer.

International Corporate Governance and Control ❖ 12

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:

23. Impact of Country Perspective on Target Valuation. Targ Co. of the U.S. has been targeted by

3 firms that consider acquiring it: (1) Americo (from the U.S.), Japino (of Japan), and Canzo (of

Canada). These 3 firms do not have any other international business, have similar risk levels, and have

a similar capital structure. Each of the 3 potential acquirers has derived similar expected dollar cash

flow estimates for Targ Co. The long-term risk-free interest rate is 6% in the U.S., 9% in Canada, and

3% in Japan. The stock market conditions are similar in each of the countries. There are no potential

country risk problems that would result from acquiring Targ Co. All potential acquirers expect that the

Canadian dollar will appreciate by 1 percent per year against the U.S. dollar and will be stable against

the Japanese yen. Which firm will likely have the highest valuation of Targ Co.? Explain.

24. Valuation of a Foreign Target. Gaston Co. (a U.S. firm) is considering the purchase of a target

company based in Mexico. The net cash flows to be generated by this target firm are expected to be

300 million pesos at the end of one year. The existing spot rate of the peso is $.14, and the expected

spot rate in one year is $.12. All cash flows will be remitted to the parent at the end of one year. In

addition, Gaston hopes to sell the company for 800 million pesos (after taxes) at the end of one year.

The target has 10 million shares outstanding. If Gaston purchases this target, it would require a 25

percent return. What is the maximum value in pesos per share that Gaston should pay for this target

company today? Show your work.

25. Divestiture of a Foreign Subsidiary. Rudecki Co. (a U.S. firm) has a Polish subsidiary that is

considering divesting. This subsidiary is completely focused on research and development for

Rudecki’s other business. Rudecki has cash outflows (paid in zloty, the Polish currency) for the

laboratories and scientists in Poland. Although the subsidiary does not generate any sales, its research

and development lead to new products and higher sales of products that are solely in the U.S. and are

denominated in dollars. There is no foreign competition. Last week, a firm offered to purchase the

subsidiary for $10 million, and the offer is still available. Today Rudecki has revised its forecasts of

the zloty upward for all future periods. Will today’s adjustment of the exchange rate forecasts

increase, decrease, or have no effect on the net present value of a divestiture of this subsidiary from

International Corporate Governance and Control ❖ 13

Rudecki’s perspective? Briefly explain. [Keep in mind that the NPV of the divestiture is not the same

as the NPV that results from acquiring a project.]

26. Poison Pills and Takeovers. Explain how a foreign target could use poison pills to prevent a

takeover or change the terms of a takeover.

ANSWER: A poison pill does not require the approval of other shareholders so it can be easily

27. Governance of MNCs by Shareholders. Explain the various ways in which large shareholders can

attempt to govern an MNC and improve its management.

28. Divestiture of a Foreign Subsidiary. Ved Co. (a U.S. firm) has a subsidiary in Germany that

generates substantial earnings in euros each year. It will soon decide whether to divest the subsidiary.

One week ago, a company offered to purchase the subsidiary from Ved Co., and Ved 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. When deciding whether a divestiture

is feasible, Ved Co. estimates the NPV of the divestiture. Will Ved’s estimated NPV of the

divestiture be larger than, smaller than, or the same as it was last week? Briefly explain.

b. If the long-term interest rate in the U.S. suddenly declines, and all other factors are unchanged, will

the NPV of the divestiture be larger or smaller or the same as it was last week? Briefly explain.

ANSWER:

a. Since the euro is depreciating, then the PVs for the divesture will lower, because the values of the

29. Valuation of a Planned Divestiture. Dallen Co. has a subsidiary in Mexico that does research and

development and produces prescription pills that are transported to and sold in the U.S. The parent

used its own funds to build the subsidiary. Dallen Co. pays for the operations in Mexico in Mexican

pesos, but all of its revenue from selling the pills in the U.S. is in dollars. It has no other international

International Corporate Governance and Control ❖ 14

business. Dallen’s competitors are local firms in the U.S. that have no international operations. Two

days ago, Dallen received an offer from a firm to buy Dallen’s subsidiary, and the offer is in effect for

a few days.

a. Yesterday, an event occurred that makes the parent of Dallen Co. believe that the Mexican peso

will weaken substantially in the future. Do you think the event that occurred yesterday will

increase, decrease, or have no impact on the likelihood that Dallen will accept the offer and sell

its subsidiary at the existing offer price? Briefly explain.

b. Today, an event occurred that caused the risk-free interest rate in the U.S. to increase. Do you

think the event that just occurred today will increase, decrease, or have no impact on the

likelihood that Dallen will accept the offer and sell its subsidiary at the existing offer price?

Briefly explain.

30. Divestiture Decision. Kylee Co. (a U.S. firm) has a British subsidiary that will generate cash flows of

3 million pounds at the end of each of the next two years. It uses the prevailing spot rate of the British

pound of $1.80 as a forecast of the future value of the pound. Its required rate of return on this

business is 16 percent. Kylee just received an offer from a British company that wants to buy the

subsidiary for $8,000,000. Assume that Kylee would not be subject to any tax on the sale.

a. Should Kylee Co. sell the business? Show your work.

ANSWER:

Year 1 Year 2

Expected CF in Pounds 3,000,000 3,000,000

b. Assume that news reports today that causes Kylee to think that the British pound will strengthen

substantially the next two years. Assume the offer price remains unchanged. If Kylee reassesses

whether to divest based on this information, do you think the potential news will increase the net

present value of the divestiture (make the divestiture more beneficial for Kylee), reduce the net

International Corporate Governance and Control ❖ 15

present value of the divestiture, or have no impact on the estimated net present value of the

divestiture? Briefly explain.

c. Assume that today the prevailing long-term U.S. risk-free interest rate decreased, and that this has

no effect on Kylee’s cash flows from operations. Assume the offer price remains unchanged. Do

you think this information about the decline in the U.S. risk-free interest rate will increase the net

present value of the divestiture, reduce the net present value of the divestiture, or have no impact

on the estimated net present value of the divestiture? Briefly explain.

CRITICAL THINKING

Valuation of Foreign Target Companies In 2011, Microsoft acquired Skype (based in Luxembourg)

for approximately $8.5 billion. Write a short essay that describes the general process that Microsoft would

have used to determine how much it was willing to pay for Skype. Some analysts claim that Skype as an

independent company was not worth $8.5 billion, but that it is worth more than $8.5 billion to Microsoft.

Explain this point in your essay.

ANSWER

Solution to Continuing Case Problem: Blades, Inc.

1. Using a spreadsheet, determine the NPV of the acquisition of Skates’n’Stuff. Based on your

numerical analysis, should Blades establish a subsidiary in Thailand or acquire Skates’n’Stuff?

ANSWER: (See spreadsheet attached.) The analysis indicates that the acquisition will result in a net

2. If Blades negotiates with Skates’n’Stuff, what is the maximum amount (in Thai baht) that Blades

should be willing to pay?

ANSWER: If Blades, Inc. were to negotiate with Skates’n’Stuff, it should attempt to pay a price that

International Corporate Governance and Control ❖ 17

Year 0

Year 1

Year 2

Year 3

Year 4

Year 5

Year 6

Year 7

Year 8

Year 9

Year 10

1. Units Sold to Retailers in Thailand

280,000

2. Price per Unit (in Thai baht)

4,500

5,040

5,645

6,322

7,081

7,931

8,882

9,948

11,142

12,479

13,976

3. Revenue from Sales to Retailers

in Thailand = (1) × (2) (in 000s)

1,260,000

1,411,200

1,580,544

1,770,209

1,982,634

2,220,551

2,487,017

2,785,459

3,119,714

3,494,079

3,913,369

4. Variable Cost per Unit (in Thai baht)

3,500

3,920

4,390

4,917

5,507

6,168

6,908

7,737

8,666

9,706

10,870

5. Total Variable Cost = (1) × (4) (in 000s)

980,000

1,097,600

1,229,312

1,376,829

1,542,049

1,727,095

1,934,346

2,166,468

2,426,444

2,717,617

3,043,731

6. Less Cost Savings from Production

of 108,000 Pairs in Thailand (000s)

32,400

—

7. Fixed Operating Expenses (in Thai

baht 000s)

20,000

22,400

25,088

28,099

31,470

35,247

39,476

44,214

49,519

55,462

62,117

8. Noncash Expense (Depreciation in

baht 000s)

60,000

9. Total Expenses = (5) – (6) + (7) +

(8) (in baht 000s)

1,027,600

1,147,600

1,314,400

1,464,928

1,633,519

1,822,342

2,033,823

2,270,681

2,535,963

2,833,079

3,165,848

10. Before-Tax Earnings of Subsidiary

= (3) – (9) (in baht 000s)

232,400

263,600

266,144

305,281

349,115

398,209

453,194

514,777

583,750

661,000

747,521

11. Host Government Tax (25%) (in 000s)

58,100

65,900

66,536

76,320

87,279

99,552

113,298

128,694

145,938

165,250

186,880

12. After-Tax Earnings of Subsidiary

174,300

197,700

199,608

228,961

261,836

298,657

339,895

386,083

437,813

495,750

560,640

13. Net Cash Flow to Subsidiary =

(12) + (8) (in baht 000s)

234,300

257,700

259,608

288,961

321,836

358,657

399,895

446,083

497,813

555,750

620,640

14. Thai Baht Remitted by Subsidiary

(100% of CF) (in baht 000s)

234,300

257,700

259,608

288,961

321,836

358,657

399,895

446,083

497,813

555,750

620,640

15. Withholding Tax on Remitted

Funds (10%) (in baht 000s)

23,430

25,770

25,961

28,896

32,184

35,866

39,990

44,608

49,781

55,575

62,064

16. Thai Baht Remitted After

Withholding Taxes (in 000s)

210,870

231,930

233,647

260,065

289,653

322,791

359,906

401,475

448,032

500,175

558,576

17. Salvage Value (000s)

1,100,000

18. Exchange Rate of Thai Baht ($)

0.02300

0.02254

0.02209

0.02165

0.02121

0.02079

0.02037

0.01997

0.01957

0.01918

0.01879

19. $ Cash Flow to Parent = (16) × (18)

4,850,010

5,227,702

5,161,080

5,629,732

6,144,827

6,710,882

7,332,857

8,016,198

8,766,879

9,591,461

31,169,086

20. PV of Parent Cash Flows (25%

Discount Rate)

4,850,010

4,182,162

3,303,091

2,882,423

2,516,921

2,199,022

1,922,265

1,681,119

1,470,838

1,287,344

3,346,755

21. Initial $ Investment by Blades

23,000,000

22. Cumulative PV ($ 000s)

(18,150)

(13,968)

(10,665)

(7,782)

(5,265)

(3,066)

(1,144)

537

2,008

3,295

6,642

International Corporate Governance and Control ❖ 18

Solution to Supplemental Case: Redwing Technology Company

a. The earnings performance translated in dollars is misleading because they are distorted by varying

exchange rates. The actual earnings in each local currency in each subsidiary should be assessed,

since the subsidiary has no control over the exchange rate used for translation. The translation causes

earnings to be overstated when the local currency is strong (against the dollar) and understated when

the local currency is weak. The following table shows the earnings of each subsidiary when

measured in the local currency. Based on this table, the Canadian subsidiary experienced a consistent

growth in earnings over time, averaging about a 14 percent increase per year. Conversely, the South

African subsidiary experienced consistent declines in earnings over time, with an average annual

earnings growth rate of –4.38%. The Japanese subsidiary experienced a decline in earnings in all but

one year, and its average annual earnings growth rate was –1.03%. When measured in this way, the

executive in charge of the Canadian subsidiary appears to have achieved the best performance. The

Annual Annual Annual

Years Percentage South Percentage Percentage

Ago Canada Increase Africa Increase Japan Increase

5 C$16.80 — R210.00 — Y7,500.00 —

4 19.92 18.57% 200.00 –4.76% 7,441.86 –.77%

2 25.92 14.28 180.00 –3.74 7,454.54 –2.03

1 28.44 9.72 175.00 –2.78 7,187.50 –3.58

b. Based on its high annual growth rate of earnings, the Canadian subsidiary would likely deserve a cash

infusion from the parent to push for additional growth. The parent would probably feel that its funds

are more likely to generate decent returns there than in other countries.

International Corporate Governance and Control ❖ 19

Small Business Dilemma

Multinational Restructuring by the Sports Exports Company

1. Are there any reasons why the business that has been so successful in the United Kingdom might not

be successful in other European countries?

2. If the business is diversified throughout Europe, will this substantially reduce the Sports Exports

Company’s exposure to exchange rate risk?

3. Now that several countries in Europe participate in a single currency system, will this affect the

performance of new expansion throughout Europe?