{"id":186,"date":"2015-07-30T01:19:19","date_gmt":"2015-07-30T01:19:19","guid":{"rendered":"https:\/\/courses.candelalearning.com\/intlbusx1xmaster\/?post_type=chapter&p=186"},"modified":"2017-01-09T19:09:52","modified_gmt":"2017-01-09T19:09:52","slug":"fundamentals-of-finance","status":"publish","type":"chapter","link":"https:\/\/courses.lumenlearning.com\/cerritos-internationalbusiness\/chapter\/fundamentals-of-finance\/","title":{"raw":"Reading: Fundamentals of Finance","rendered":"Reading: Fundamentals of Finance"},"content":{"raw":"
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Learning Objectives<\/h3>\r\n
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  1. Know the various financing options available to international firms.<\/li>\r\n\t
  2. Explain the value of capital budgeting.<\/li>\r\n\t
  3. Understand the role of governments in affecting investment decisions.<\/li>\r\n<\/ol>\r\n<\/div>\r\n
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    Financial Structure and Sources of Financing<\/h2>\r\nAs demonstrated in the opening case study, governments, banks, and individuals all play a role in international financing. Businesses get external capital from these sources\u2014capital that lets them build, expand, and grow.\r\n\r\nFinancial structure<\/span><\/span> refers to the ways in which a multinational firm\u2019s assets are financed\u2014from short-term borrowing to long-term debt and equity. Managing a multinational firm\u2019s financial structure involves asking: What is the ideal mix of debt versus equity to finance international operations? Where should these funds be invested?<\/em> Multinational firms engage in both transnational financing<\/span><\/span> (i.e., seeking capital from a foreign sources) and transnational investment<\/span><\/span> (i.e., investing capital in foreign markets).\r\n\r\nSources of financing available to firms include foreign stock exchanges, foreign bond markets, foreign banks, venture-capital firms, and funding from the parent company. Although global equity and debt markets offer firms a new way to get funding\u2014often at lower cost than US markets\u2014they are also complicated by foreign currency and exchange rates.\r\n\r\nEquity financing<\/span><\/span> refers to raising capital by selling shares of stock. The stock market<\/span><\/span> refers to the organized trading of securities through exchanges. An individual or entity can purchase partial ownership in a corporation, buying shares of stock in the company. The global equity market<\/span><\/span> refers to all stock exchanges worldwide where firms can buy and sell stock for financing an investment.\r\n\r\nThe largest exchanges in the world include the New York Stock Exchange (NYSE) Euronext, the Tokyo Stock Exchange, NASDAQ (National Association of Securities Dealers Automated Quotations) stock exchange, and the London Stock Exchange. The advantage of raising capital in equity markets is that the firm doesn\u2019t have to repay the money at a specific time or at a specific interest rate, as it does with bank loans. The disadvantage is that each time a firm offers stock, the firm\u2019s management loses some control of the company because shareholders can now vote to approve or disallow management actions.\r\n\r\nDebt financing<\/span><\/span> refers to raising capital by borrowing the money and agreeing to repay the entire amount plus agreed-on interest at a specific date in the future. Firms can borrow money from banks or by selling bonds. The advantage of raising money through debt financing is that company management doesn\u2019t give up any ownership of the firm.\r\n\r\nFirms can also obtain funding via intrafirm loans or trade credits. A trade credit<\/span><\/span> lets the customer (in this case, the subsidiary buying the goods or services) defer payment on the good or service for a specified period of time, typically thirty or ninety days. By borrowing capital from a parent, both the subsidiary and the parent eliminate paying transaction costs to an outside entity such as a bank, which would charge fees to make the transaction.\r\n\r\n<\/div>\r\n
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    Financing Options Available to Subsidiaries<\/h2>\r\nSubsidiaries can choose between two major ways to finance their operations through external sources: overseas equity markets and overseas debt markets. Let\u2019s look at each in turn.\r\n
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    Raising Money in Overseas Equity Markets<\/h2>\r\nMultinational firms choose to raise money in foreign markets for a number of reasons. For example, French luxury beauty products company L\u2019Occitane conducted its initial public offering (IPO) on Hong Kong\u2019s stock exchange, rather than on the stock exchange in its home country\u2014the NYSE Euronext in Paris.[footnote]Peter Bisson, Rik Kirkland, and Elizabeth Stephenson, \u201cThe Great Rebalancing,\u201d McKinsey Quarterly<\/em>, June 2010, accessed October 28, 2010, http:\/\/www.mckinseyquarterly.com\/The_great_rebalancing_2627<\/a>.[\/footnote]<\/span> L\u2019Occitane made this decision because emerging-market consumers are its fastest-growing segment. Listing on Hong Kong\u2019s exchange makes the company more visible in these growing markets and lets locals participate in the growth of the firm by buying shares.\r\n\r\nSome multinational firms raise money in both their home-country and overseas stock exchanges. One of the reasons for listing on multiple exchanges is a lower cost of capital as shares become available to global investors who might not otherwise be able to purchase shares due to international investment barriers.\r\n\r\nEmerging markets are also opening stock exchanges. For example, the Shanghai and Shenzhen Stock Exchanges in China opened in 1990. In July 2010, the Shanghai Stock Exchange became the sixth-largest stock exchange in the world based on market capitalization.\r\n
    \r\n\r\n[caption id=\"\" align=\"aligncenter\" width=\"500\"]\"Shanghai<\/a> Figure 15.1<\/b> Shanghai Stock Exchange. Courtesy of Jindao Floors Inc.[\/caption]\r\n\r\n<\/div>\r\nPublic share ownership in China remains complex with three classes of shares: A, B, and H. A-shares are local shares denominated in China\u2019s local currency for domestic investors. B-shares are denominated in Hong Kong dollars or US dollars and are generally owned by foreigners. H-shares are for China-incorporated companies traded in Hong Kong. Chinese authorities (the China Securities Regulatory Commission, the People\u2019s Bank of China, and the State Administration of Foreign Exchange) closely regulate the Shanghai and Shenzhen Stock Exchanges. Indeed, the Chinese government actively intervenes in its capital markets. For example, it didn\u2019t allow any new equity funds to be established in 2007. The government also owns a relatively high number of shares in many listed companies. China\u2019s low transparency, poor implementation of securities regulations, and restrictions on hedging and risk-management tools are warning signs to foreign investment-fund executives. At the same time, the government lacks many regulations related to educating or protecting investors. A brokerage firm can allow an investor to buy and sell any amount of any security after the investor answers three questions in the following areas: name, health, and risk tolerance.[footnote]Matt Anderson, Daniel Curtis, Derek Lin, and Ian Van Reepinghen, \u201cComing of Age: A Look at China\u2019s New Generation of Investors,\u201d in The Lauder Institute, Lauder Global Business Insight Report 2010: First-Hand Perspectives on the Global Economy<\/em> (Philadelphia: Wharton, University of Pennsylvania, 2010), 69\u201373, accessed October 28, 2010, http:\/\/knowledge.wharton.upenn.edu\/papers\/download\/021710_GlobalBiz_2010.pdf<\/a>.[\/footnote]<\/span>\r\n\r\n<\/div>\r\n
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    Raising Money in Overseas Debt Markets<\/h2>\r\nMultinational firms can issue bonds in overseas markets as well as in their home countries. Even China now has an active bond market. Before April 2008, Chinese state-owned enterprises were about the only ones issuing corporate debt in China because corporate bonds were so costly and time-consuming to issue there. Corporate bonds had to be listed on the stock exchange and approved by exchange regulators, making the process subject to political whims. State-owned enterprises raised money in the bond market to finance big infrastructure projects, and the bonds had state guarantees. In 2008, new rules simplified the issuing process, and the Chinese government began letting foreign companies issue yuan-denominated bonds through Hong Kong in 2010. The attraction of the Chinese bond market, according to Chris Zhou, director of debt capital markets at UBS Securities in Beijing, is that \u201cthe bond market is a relatively easy and cost-effective way to get money.\u201d[footnote]Frederik Balfour, \u201cIn China, A Burst of Corporate Bonds,\u201d BusinessWeek,<\/em> July 6, 2009, 25.[\/footnote]<\/span>\r\n\r\nMcDonald\u2019s was the first foreign company to issue yuan-denominated bonds, selling 200 million yuan (or $29 million) of 3 percent notes due in September 2013. As Donald Straszheim, senior managing director and head of China research at the International Strategy & Investment Group observed, \u201cThere are hundreds of global companies wanting to do more business in China, and they will want to be involved in the country\u2019s evolving credit market.\u201d[footnote]Patricia Kuo and Shelley Smith, \u201cMcDonald\u2019s Sets Benchmark for China With Yuan Bond Sale,\u201d Bloomberg<\/em>, August 20, 2010, accessed August 23, 2010, http:\/\/www.bloomberg.com\/news\/2010-08-19\/mcdonald-s-yuan-bonds-set-standard-as-china-promotes-debt-credit-markets.html<\/a>.[\/footnote]<\/span>\r\n\r\nAccording to McDonald\u2019s spokesperson Lisa Howard, issuing bonds in China \u201cgives us access to new funding to support growth in China. We are very confident in the Chinese market and have a strong plan to grow our business in China.\u201d[footnote]Patricia Kuo and Shelley Smith, \u201cMcDonald\u2019s Sets Benchmark for China with Yuan Bond Sale,\u201d Bloomberg<\/em>, August 20, 2010, accessed August 23, 2010, http:\/\/www.bloomberg.com\/news\/2010-08-19\/mcdonald-s-yuan-bonds-set-standard-as-china-promotes-debt-credit-markets.html<\/a>.[\/footnote]<\/span> McDonald\u2019s will use the money it has raised in the bond market to provide working capital for expansion in China, including opening as many as 175 restaurants in 2010, adding to the 1,000 restaurants it already has there.\r\n
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    Innovation and Entrepreneurship<\/h3>\r\n

    WaterHealth: Financing for Entrepreneurs in Developing Countries<\/h4>\r\nWaterHealth is a company that sells and leases water purification systems for use in developing countries. The company also sells and leases special sanitary water containers that reduce the spread of waterborne diseases from contaminated ladles. WaterHealth developed ultraviolet technology to sanitize water. The technology doesn\u2019t require large-scale operations or equipment, which enables local entrepreneurs in developing countries to use the technology to open their own water shops to sell water to local customers. The result? Consumers gain access to cheaper, cleaner water, while the local economy gains new businesses. WaterHealth\u2019s innovative financing doesn\u2019t require high up-front payments for its technology. Instead, the company collects user fees, allowing the repayment of financing costs over time.[footnote]WaterHealth International, \u201cFrequently Asked Questions,\u201d accessed August 14, 2010, http:\/\/www.waterhealth.com\/<\/a>.[\/footnote]<\/span>\r\n\r\n<\/div>\r\n<\/div>\r\n<\/div>\r\n
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    Investment Decisions<\/h2>\r\n
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    Capital Budgeting<\/h3>\r\nCapital budgeting<\/span><\/span> refers to the process of financing long-term outlays for major projects such as plant expansion, entry into new markets, or research and development. The process of capital budgeting helps a firm decide which major investment projects will be most economically advantageous for the firm by assessing each project\u2019s benefits, costs, and risks. When making capital-investment decisions, firms examine the initial investment that will be required, the cost of capital, and the amount of cash flow or other gains which the project will provide. The cost of capital<\/span><\/span> is the rate of return that a company could earn if it chose a different investment of equivalent risk. The cost of capital comes into play because firms have choices in how to put their capital to use; using the capital for one purpose precludes using it for a different purpose.\r\n\r\nSome governments court foreign borrowers by offering low-interest loans or by offering lower corporate income tax to attract investment in their countries. For example, Poland created special tax breaks for companies. These tax breaks make the country attractive for firms such as Hewlett-Packard and IBM to locate operations there. Similarly, Singapore\u2019s government has invested heavily in education and training in an effort to attract investment by leading multinational firms. Singapore also offers subsidies to companies locating there. As corporations think about where to invest, build factories, locate offices, and source talent, they explore such opportunities actively.[footnote]Peter Bisson, Rik Kirkland, and Elizabeth Stephenson, \u201cThe Market State,\u201d McKinsey Quarterly<\/em>, June 2010, accessed October 28, 2010, http:\/\/www.mckinseyquarterly.com\/The_market_state_2628<\/a>.[\/footnote]<\/span>\r\n\r\n<\/div>\r\n
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    How Government Actions Affect Investment Decisions<\/h2>\r\nGovernment policy affects foreign investment and innovation. According to Jeffrey Sachs, a leading international economic advisor and Columbia University professor, the near-term prospects for Brazil are bright, and it\u2019s poised to do the best among Latin American countries.\r\n
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    Brazil<\/h3>\r\nFor the last fifteen years, Brazil has been investing heavily in education. In particular, Brazil made high school available to all citizens and invested in higher education, science, and technology. The result of these government investments is that not only does Brazil have a more educated workforce, but it has also narrowed off the gap between rich and poor and between ethnically divided segments of Brazilian society. In contrast, countries with deep ethnic and racial inequities aren\u2019t unified societies, which leads to mediocre economic performance. Brazil plans to invest another $22 billion in science and technology innovation in 2010 and seeks corporations to join in additional investments in the country.[footnote]Jeffrey Sachs, \u201cEconomics for a Crowded Planet\u201d (webinar, HSM Global, 2009), accessed October 28, 2010, http:\/\/us.hsmglobal.com\/contenidos\/hsm-webinars-sachs.html<\/a>; Jeffrey Sachs, The End of Poverty: Economic Possibilities for Our Time<\/em> (New York: Penguin, 2005).[\/footnote]<\/span>\r\n\r\nIBM is one of the companies investing in Brazil. CEO Sam Palmisano met with Brazilian President Luiz Inacio Lula Da Silva to discuss the creation of a \u201ccollaboratory\u201d in Brazil. IBM\u2019s collaboratories match IBM researchers with local experts from governments, universities and companies. IBM\u2019s Palmisano praised Brazil\u2019s strategy: \u201cInvestments in innovation are critical, especially in a downturn. They can help Brazil and other countries, including the US, realize an economic expansion.\u201d Among the BRIC countries (Brazil, Russia, India, and China), Brazil is seeing the highest growth in business partners that IBM works with, averaging 150 percent year over year, according to Claudia Fan Munce, managing director of IBM Venture Capital Group.[footnote]Steve Hamm, \u201cBig Blue\u2019s Global Lab,\u201d BusinessWeek<\/em>, August 27, 2009, accessed October 28, 2010, http:\/\/www.businessweek.com\/magazine\/content\/09_36\/b4145040683083.htm<\/a>; Spencer E. Ante, \u201cIBM Bets on Brazilian Innovation,\u201d BusinessWeek<\/em>, August 17, 2009, accessed October 28, 2010, http:\/\/www.businessweek.com\/technology\/content\/aug2009\/tc20090817_998497.htm<\/a>.[\/footnote]<\/span>\r\n\r\nAs the above example illustrates, Brazil is attracting foreign business. Companies making foreign investments, however, must be aware of the total financial picture, including the tax environment. Brazil has a very complex tax system. \u201cIf it\u2019s not the most complicated tax system in the world, it\u2019s certainly right up there,\u201d said Mark Buthman, finance chief at Kimberly-Clark, the consumer packaged goods giant, which has approximately 3,000 people in its Brazilian operation. \u201cIt\u2019s not uncommon to have disagreements with the taxing authorities that you have to work through over time.\u201d[footnote]Kate O\u2019Sullivan, \u201cBrazil Is Booming (and Maddening),\u201d CFO<\/em>, July 15, 2010, accessed October 28, 2010, http:\/\/www.cfo.com\/printable\/article.cfm\/14508833<\/a>.[\/footnote]<\/span> What makes doing business in Brazil challenging is that the tax laws have not kept pace with the progress of modern products or services; that is, the categories of taxes do not correspond to modern-day categories of products and services. The lack of parallelism leads to confusion and misinterpretation. To deal with the difficulties, Kimberly-Clark, for example, employs seventy people\u2014most of them native Brazilians\u2014in its finance group in Brazil.\r\n\r\nIn addition to federal taxes, Brazilian states assess their own taxes as well. Thack Brown, CFO of SAP Latin America, says that any misstep regarding a labor or tax regulation can prove costly. \u201cIf you do have an issue, not only can the penalties be large, but you can spend three or four or even 10 years working through the judicial system.\u201d[footnote]Kate O\u2019Sullivan, \u201cBrazil Is Booming (and Maddening),\u201d CFO<\/em>, July 15, 2010, accessed October 28, 2010, http:\/\/www.cfo.com\/printable\/article.cfm\/14508833<\/a>.[\/footnote]<\/span> Despite the difficulties, Brown says that compared to China, the Brazilian system is still more structured and capable of dealing with issues.[footnote]Kate O\u2019Sullivan, \u201cBrazil Is Booming (and Maddening),\u201d CFO<\/em>, July 15, 2010, accessed October 28, 2010, http:\/\/www.cfo.com\/printable\/article.cfm\/14508833<\/a>.[\/footnote]<\/span>\r\n\r\n<\/div>\r\n
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    Indonesia<\/h3>\r\nIndonesia is the third-largest democracy in the world and the largest economy in Southeast Asia. The country recently created an investment coordinating board to attract foreign direct investment into Indonesia. How is Indonesia making itself attractive to foreign investors?\r\n
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    1. It\u2019s touting its young population\u2014half of the population is under thirty years of age, which bodes well for a skilled workforce and growing consumer base.<\/li>\r\n\t
    2. It\u2019s touting its political stability of twelve years after democratization, and monetary stability for the last five to six years.<\/li>\r\n\t
    3. It\u2019s investing in infrastructure. \u201cWe are committing $50 billion from a budgetary standpoint for the development of infrastructure as part of a $150 billion five-year program,\u201d said Gita Wirjawan, Indonesia\u2019s chairman of Badan Koordinasi Penanaman Modal (BKPM), the country\u2019s newly created investment coordinating board. \u201cThat will produce 20,000 kilometers of new roads and an additional 15,000 megawatts of power generation. That is going to create a much higher degree of connectivity than what we have today.\u201d[footnote]\u201cWhy Gita Wirjawan Wants to Open Indonesia to International Investors,\u201d Knowledge@Wharton<\/em>, July 21, 2010, accessed August 9, 2010, http:\/\/knowledge.wharton.upenn.edu\/article.cfm?articleid=2553<\/a>.[\/footnote]<\/span><\/li>\r\n<\/ol>\r\nDespite these advances, Indonesia still restricts which industries foreign investors can invest in. For example, investors can\u2019t invest in telecommunications towers. Nonetheless, Indonesia has attracted some major investors, such as a large Middle Eastern investor who will build an integrated infrastructure project including a port, a rail track, and new power-generation capability. The total investment will be about $5.2 billion. Indonesia has also convinced the Swiss firm Holcim to expand its cement capabilities in Indonesia.[footnote]\u201cWhy Gita Wirjawan Wants to Open Indonesia to International Investors,\u201d Knowledge@Wharton<\/em>, July 21, 2010, accessed August 9, 2010, http:\/\/knowledge.wharton.upenn.edu\/article.cfm?articleid=2553<\/a>.[\/footnote]<\/span>\r\n\r\n<\/div>\r\n
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      The Role of Government<\/h2>\r\nThe role of government in terms of international business and finance includes\r\n