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
Measuring an MNC’s Benefits of DFI
Benefits of International Diversification
Host Government Views of DFI
Incentives to Encourage DFI
Barriers to DFI
Government-Imposed Conditions to Engage in 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
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
the DFI decision? (This question is not explicitly covered in the text but allows students to consider
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 with Liberal 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:
• How old does an employee have to be?
• Should it attempt to hire older workers first?
• What wage is reasonable for a child?
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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 computer disks,
plans to establish a subsidiary in Mexico in order 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 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, while 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 cash flow volatility once the plans are achieved?
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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.
6. Capitalizing on Low-Cost Labor. Some MNCs establish a manufacturing facility where there is a
relatively low cost of labor, but they sometimes close the facility later because the cost advantage
dissipates. Why do you think the relative cost advantage of these countries is reduced over time?
(Ignore possible exchange rate effects.)
7. Opportunities in Less Developed Countries. Offer your opinion on why economies of some less
developed countries with strict restrictions on international trade and DFI are somewhat independent
from economies of other countries. Why would MNCs desire to enter such countries? If these
countries relaxed their restrictions, would their economies continue to be independent of other
economies? Explain.
ANSWER: Countries that are unrelated to other economies are desirable because business in these
8. Effects of September 11. In August 2001, Ohio Inc. considered establishing a manufacturing plant
in central Asia, which would be used to cover its exports to Japan and Hong Kong. The cost of labor
was very low in central Asia. On September 11, 2001, the terrorist attacks on the U.S. caused Ohio to
reassess the potential cost savings. Why would the estimated expenses of the plant increase after the
terrorist attacks?
9. DFI Strategy. Bronco Corp. has decided to establish a subsidiary in Taiwan that will produce stereos
and sell them there. It expects that its cost of producing these stereos will be one-third the cost of
producing them in the United States. Assuming that its production cost estimates are accurate, is
Bronco’s strategy sensible? Explain.
10. Risk Resulting from International Business. This chapter concentrates on possible benefits to a
firm that increases its international business.
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a. What are some risks of international business that may not exist for local business?
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
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:
13. DFI Strategy. Once an MNC establishes a subsidiary, DFI remains an ongoing decision. What does
this statement mean?
14. Host Government Incentives for DFI. Why would foreign governments provide MNCs with
incentives to undertake DFI there?
Advanced Questions
15. DFI Strategy. JCPenney has recognized numerous opportunities to expand in foreign countries and
has assessed many foreign markets, including Brazil, Greece, Mexico, Portugal, Singapore, and
Thailand. It has opened new stores in Europe, Asia, and Latin America. In each case, the firm was
aware that it did not have sufficient understanding of the culture of each country that it had targeted.
Consequently, it engaged in joint ventures with local partners who knew the preference of the local
customers.
a. What comparative advantage does JCPenney have when establishing a store in a foreign country,
relative to an independent variety store?
b. Why might the overall risk of JCPenney decrease or increase as a result of its recent global
expansion?
ANSWER: Its risk may decrease because it has a strategy that allows it to utilize its expertise, while
c. JCPenney has been more cautious about entering China. Explain the potential obstacles
associated with entering China.
16. DFI Location Decision. Decko Co. is a U.S. firm with a Chinese subsidiary that produces cell phones
in China and sells them in Japan. This subsidiary pays its wages and its rent in Chinese yuan, which is
stable against the dollar. The cell phones sold to Japan are denominated in Japanese yen. Assume that
Decko Co. expects that the Chinese yuan will continue to stay stable against the dollar. The
subsidiary’s main goal is to generate profits for itself and it reinvests the profits. It does not plan to
remit any funds to Decko, the U.S. parent.
a. Assume that the Japanese yen strengthens against the U.S. dollar over time. How would this 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:
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 this 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 about 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. By complying with the laws, 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 direct foreign investment is feasible.
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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?
ANSWER: If Blades undertakes the direct foreign investment now, the initial outlay required will be
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?
ANSWER: If Blades renews the agreement with the Thai retailer, it will have to maintain the
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 a subsidiary 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
employed by Blades to manufacture roller blades, the Thai government would be faced with a
tradeoff if Blades would like to establish a subsidiary in Thailand. On the one hand, locally owned
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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,
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?