Financing and Control of Foreign Units

26 Pages   |   6,789 Words

Abstract

Global companies are faced with several financial challenges. These financial challenges source from the differences in economies of countries. However, these differences can also present opportunities for companies to increase price competitiveness and increase the profitability of the companies. This report discusses the challenges faced by multinational companies. These challenges include the challenges of financing internationally located subsidiaries. In these cases, the benefit of the overall company is also a priority for the company. Furthermore, the paper included propositions for multinational companies to increase their profits by reducing costs, and decreasing the risks associated with the globalization of operations. The first proposition was related to the advantages that the multinational company can gain from the countries in which the manufacturing costs are low. This recommendation was based on a famous concept of the ‘Bottom of the Pyramid’ to increase the profitability of the company. The second proposition was related to the reduction of the risks associated with countries in which the exchange rates fluctuate frequently. The proposition was to raise financing in the host country to eliminate the risk of transaction losses that come if financing for such countries is generated in other markets and currencies. The third proposition was related to the recommendations to multinational companies initializing operations in foreign markets. The recommendations given were based on the principle of reducing financing costs for the company.

 
Table of Contents
Abstract 2
Literature Review.. 4
Global Financial Environment 5
Foreign Exchange Risk. 6
Financing Foreign Units. 8
Investing Decisions. 9
Controlling Foreign Units. 11
Literature Gap. 13
Propositions. 15
Application of Propositions. 16
Low Currency Value Countries. 16
Fluctuating Currency Rates. 18
Initializing a Foreign Subsidiary. 20
Conclusion. 22
References. 25
 

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Literature Review

The increase in globalization, deregulation, and internationalization has significantly impacted local businesses as well as businesses that have located their business unit internationally. In this environment, technology and the increase in the ease of communication has allowed companies to control and maintain international units. However, the uncertainty associated with foreign operations risk the financial situation, as well as the business situation of a company. The expansion to an international location shows the openness of the business economically. This is because, the magnified threat of competition in the international market, as well as the suppliers, increases the complexity of operations in a company (Jamborova, 2012).
The international market is characterized by changing conditions that lead to financial uncertainties. Financial risks include the changing currency values that impact the value of products across borders (Hill, 2008). For international operations, there are a few options available for financing. Internationalizing operations coerces companies to find new sources of financing that are cost effective for the company. The reason is that companies aim to minimize costs. From the factors that can minimize costs, transferring currency from one country to the other, is a cost that can be reduced by global financing options (Cavusgil, Knight, & Reisenberger, 2008).
This paper will assess the financing function contributing to the control of internationally located units. It will present a discussion on the global financial environment. The main features of risk in global financing will also be discussed in detail. The paper will then examine the financing options available for global units and assess investing decisions that are impacted by a variety of factors such as economic situation of the country in which the foreign unit is located, political situations and legal aspects. Examples will be discussed throughout the paper to explore the topic and its implications in depth.

Global Financial Environment

With the globalization of operations, the finance functions in companies have increased in scope, presenting opportunities as well as challenges for companies that have expanded internationally. Country risks, tax implementation, and currency risks impact the decisions in capital budgeting. This is because companies try to optimize the results gained from internationalization, not bear losses by risky budgeting decisions. In these cases financing international operations strategically is necessary to maximize returns on international investment (Desai, 2008). According to Ehrhardt & Brigham (2009), this increase in scope has been because of the connectivity of all subsidiaries under a multinational corporation. This would mean that the resources for the company’s operations worldwide would be obtained from any country that presents the opportunity to lower financial costs for the company, leading to efficient operations. Companies are seeking to expand not only to increase their sales and grow the company but to increase production efficiency and seek better technology for their products.
However, these benefits cannot be gained in certain conditions. Mukherjee (2002) stated that these conditions limit the capability of multinational corporations to improve efficiency and production. Firstly, the import restriction in some companies compel multinationals to produce in the company rather than import from high productivity or low-cost countries. Other than that, delays in payments and raising finance limit the working capacity of subsidiaries.
Leuz & Oberholzer-Gee (2003) explored that the decision to raise foreign securities for subsidiary financing is impacted by the fact that foreign securities are scrutinized by investors, analysts, regulators, and the press. Such scrutiny means that the company’s position and reputation are at stake. Financial losses and weak financial position give a negative impact on the company. Therefore, assessing the foreign financial environment is necessary not only to profit from global subsidiaries but also to improve the position and reputation of the company globally. It is also impacted by the fact that publicly offered securities mean that the company make its operations and financing transparent. This transparency increases the scrutiny of the company and the costs allocated to assessing the financial position of the company.
The global finance environment presents several options to multinational corporations to finance their subsidiaries. Companies have options of equity financing, debt financing, and intra-corporate financing. All these options are assessed according to the financial and economic condition of the country. The currency value, environmental risk, and company financial standing are some of the factors that are considered while making decisions for financing in the global environment (Cavusgil, Knight, & Reisenberger, 2008).

Foreign Exchange Risk

The fluctuating currencies present risks for the company because of the changes in the valuation of products and expenses. The risks of fluctuations in foreign currency can be reduced by strategic measures in financing. According to Beenhakker (2001), if the foreign currency has a greater impact on cash inflows, the recommendation is that the foreign sales be reduced, foreign supply be increased and restructure the financing of the subsidiary to increase debt in foreign currency. The impact on cash inflow means that the currency fluctuates to decrease the value of the currency most often. The recommendations for fluctuation impact on cash outflow, or where expenses are greater were also given. These recommendations were opposite of the recommendations given for fluctuations of a decrease in value. In case the country’s currency is increasing in value, the sales should be increased, supplies should be decreased, and the debt payments should be reduced.
Ehrhardt & Brigham (2009) agree to the recommendations given by Beenhakker (2001). The recommendation that the decrease in value of the currency of the host country should be dealt with greater supplies refers to trading. Since the multinational companies are connected, sourcing raw materials or products from countries with low-value currencies would give greater benefits to the parent company. The company would be benefiting from the lowering value of the currency.
Madura (2012) further explained the affects of fluctuations in currency on company financing decisions. In case the currency of the subsidiary is lower in value compared to that of the parent company, the debt structure in foreign currency can be increased rather than obtaining financing from the parent company. The reason is that the repayments and interest payments will be made in the weaker currency, reducing the cost of debt financing. In case the currency improves compared to the parent company’s currency, the earnings should be reinvested to obtain more of the currency. The debt structure would be reduced because the interest rates would be greater as compared to the interest paid in a weaker currency form.
The foreign exchange rate issues also emerge in the case of transacting finance raised by the parent company in a currency other than what is required by the subsidiary. The example illustrated by Williams, Carcello, and Neal (2009) showed a US based company generating financing for its subsidiary in Greece. It was identified that the first step to raising finance would be to assess the amount required in the subsidy. The US Company would then convert this amount to US dollars and raise that amount from US financial institutions. However, during the time spent in raising finance, if the currency of the subsidiary appreciates, the amount that is generated would not be enough to finance the operations. The reason is that it would be fewer than what was assessed in the first step. The foreign currency loan (in US dollars) is a hedge for the company.

Financing Foreign Units

According to Buckle, Buckle, and Thompson (2004), foreign subsidiaries depend on financing from parent companies to a certain extent. The financing for foreign subsidiaries cannot be completely dependent on raising finance in the international market. Loans given by parent subsidiaries hold the advantages of capital investments. The reason is that the threat of insolvency is lesser as compared to loans from international capital markets. In the case that a subsidiary requires financing, and it is situated in a country in which tax rates on corporations are higher than the tax implemented in the home-country, intra-organizational financing is a good option. The reason is that with the parent company giving loans, the interest rates are charged as high as is allowed. This allows the company to minimize the taxes because interest payments are not taxed. Cavusgil, Knight, and Reisenberger (2008) stated that this parent company financing or subsidiaries financing other subsidiaries is called intra-corporate financing. In this case, the parent company benefits because of a reduction of taxes, and the interest payments coming to the company rather than to an external financing institution. IBM works on the same principal of intra-corporate financing.
Other options available for the company for financing, according to Madura (2012), is raising money in the parent company’s country. These companies offer bonds in the currency of the country in which the parent company is located. They offer bonds that usually have long maturity periods, and these bonds can be sold to investors. However, to use this financing for foreign subsidiaries, the companies convert the loan into the local currency of the subsidiary’s country. Other loan-based financing also includes getting loans from the host country’s financial institutions such as stock exchanges and banks. The loans are set to a currency that has a lower interest rate as interest rates if different currencies can be different given the fluctuation of a currency’s value. Vaghefi, Paulson, and Tomlinson (2001) also identify the financing done by getting investments from other international countries. Companies develop finance subsidiaries and use these subsidiaries to raise money at extremely low costs. These finance subsidiaries do this by raising finance in countries that are a tax haven. Examples of these countries are the Bahamas, Liechtenstein, and Switzerland. This is done to minimize tax costs to the company.
However, even though options for raising finance from international markets is possible, companies still resort to raising financing from host countries. According to Leuz & Oberholzer-Gee (2003), the reason companies invest in host country financial securities that are publicly traded is that political relations are established. This allows the subsidiary to have larger market shares in case the government is involved in financial systems of the country. However, investment in foreign, publicly traded securities means that the operations of the company are not transparent. This puts the company at a disadvantage since strategies are assessed for an assessment of their financial performance.
Williams, Carcello, and Neal (2009) identified that the risk involved in the currency fluctuation is one other factor because of which companies resort to raising finance in the currency and the country in which the subsidiary is located. However, Vaghefi, Paulson, and Tomlinson (2001) identified that economic conditions of the host country also determine the financing sources. The cases in which the country does not have the capability to produce funds despite favorable currency situations, the company has to resort to other means of financing for their subsidiaries.

Investing Decisions

Desai (2008) stated that chief finance officers have to be strategic about decision-making. The reason is that discount rates differ with every country. There are differences in the rates at which companies can borrow capital for investment. The assessment of the inflows of cash in the invested operations and its valuation to the discount rates given should be done to minimize costs for financing and increasing the returns from investments. This assessment is less complex in the domestic environment, but its complexity increases in the global market because of the other factors that impact the riskiness of the situation.
Madura (2012) discussed cash flows and debt structure of the company. Multinational corporations that have a stable cash flow from its existing operations can resort to investing in operations with debt. The reason is that stable cash flows mean that the company would be able to pay interest amounts. However, in the case of irregular or unstable financial condition, the operations and subsidiaries should gain investment by equity financing because of the uncertainty of the ability to pay back loans and interest. However, one other case is that those companies that have an established equity base and retained earnings can go for equity-based financing rather than increasing debt expenses. Levi (2000) stated one other factor that impacts the decisions of debt structuring in a company. In some countries, the costs associated with the scrutiny of publicly traded securities is high. The scrutiny and grading of securities are also compulsory to increase the valuation of the company. In this case, debt financing would be a better option. The costs of debt financing and financing through foreign financial institutions should be analyzed and compared to find out the best solution.
According to Un and Cuervo-Cazurra (2008), investing decisions should be controlled by the parent company even though the decentralized structure is now prevalent in companies. The reason is that investment decisions impact the company. Research and development investment decisions specifically should be guided by parent company managers. One other reason is that parent company managers are experienced, and the investment would get substantial returns. The main aim of investing is getting high returns on them. The guidance, not full control by the parent company managers can help subsidiaries to increase their returns. Full control should not be taken because of the situation of the host country about which the subsidiary manager would have greater information.
The profits made by subsidiaries are often invested in the business or the parent company. However, according to Lu, Verheyen, and Perera (2009), such investments might give rise to political risks. The example of Tamasek Holdings in Indonesia was getting investments from its subsidiaries. However, the increase in investments had resulted in Tamasek gaining power because of its growth in Indonesia. The company had been formed into a monopoly and was subject to political threats and conflicts.

Controlling Foreign Units

Vedder (2008) stated that the control of foreign units starts with the assessment of the subsidiary. This assessment includes a performance evaluation of the subsidiary, including factors such as financial performance, return on investment, and financial profits. The main figure for performance evaluation is the Return on Investment (ROI) figure. However, companies tend to evaluate managerial performance as a part of the assessment. Controlling foreign units does include a managerial assessment, but the performance evaluations should be separated.
With the increase in decentralization, the business units operating globally make decisions that are not approved by the parent company. One such example is that of Johnson and Johnson, a leading company in healthcare with units in more than 60 countries globally. With an extensive structure like Johnson and Johnson, it is difficult to control the units with a centralized structure (Johnson & Johnson, 2015). Daniels, Radebaugh, Sullivan, and Salwan (2010) dsicussed the case of Johnson and Johnson. In 2007, the company was faced with the consequences of decisions of its subsidiaries. The decision concerned some payments that were stated to be improper and against the policies of the company. The company was on the verge of being held responsible for violation of laws; the foreign corrupt practices act. The company resorted with the early retirement of the person responsible, the worldwide chairman of diagnostics and medical devices. Even though finance is a function that is scrutinized in foreign subsidiaries, Levi (2000) stated that the parent companies should allow subsidiaries to make changes in debt and equity according to the conditions of the country. The main reason is that the country’s conditions can only be known by the managers in the subsidiary, and not the managers in the parent company. Centralizing financing decisions would limit the subsidiary’s capability to gain advantage from foreign financial markets.
Novartis is a leading drug manufacturer present globally. The company faced a tough decision in 2001 when the Turkish subsidiary had delayed payments to the company for a long time. This was because of the crisis in the country. The two options available to the company was either to stop shipments to the Turkish subsidiary or to find local funding for the subsidiary. The company allocated a fiancé team that held experience from other subsidiaries of the company. It eventually was able to pay its dues to the parent company. The recommendation is that companies that invest globally invest in the human resource in finance and gain from the developed skill set and experience of its employees (Desai, 2008). 
The control of foreign units also includes assessing the subsidiary’s performance and setting the direction of the company. According to Vedder (2008), this includes further investment in subsidiaries that are performing well, and the reduction of production or implementing different strategies to improve performance of the subsidiary. Control should also be based on the assessment of operations that are performing well in organizations and guiding subsidiary managers to focus on those operations. It also means aligning organizational goals with the subsidiary and increasing the profitability of the organization as a whole.

Literature Gap

This literature review covers most of the aspects of financing a foreign subsidiary. It discusses the general risks and concerns with financing foreign subsidiaries, the risk of foreign exchange, and the options available to the parent company to finance the subsidiary. The main aim of companies that globalize their operations is to maximize their profits, reduce costs, increase productivity, and exploit financial conditions of other countries. Countries with low finance costs, or low valued currency are usually chosen for production of products because of the advantage gained from the difference in currency value.
However, this difference in currency value also gives rise to foreign currency risk. Sales and the marginal profits are impacted in case of a currency that is depreciating. However, appreciating currencies also present challenges regarding debt financing and exports. The exchange rate risk is also present in the case of raising finance for host countries from other countries or the country in which the parent company is located. This report also discussed the financing options available for companies for subsidiaries. There were several situations assessed in which some sorts of financing is more beneficial that other. Equity financing, debt financing, and intra-corporate financing were the three broad options for fund-raising.
One other issue discussed was the decision to invest. Companies work to maximize returns on their investment. Therefore, investing decisions should be made, keeping in view the conditions in the country and the subsidiary. Investing in subsidiaries should follow after an assessment of the subsidiary’s performance. Further investments should be made by assessing the financial gains from the subsidiary. Lastly, it was discussed that foreign units should be controlled by centralizing some decisions such as investment in R&D functions.
However, the literature review does not present an integrated research on the finance and control of foreign subsidiaries. The secondary research provides several options that a company has available for financing as well as the risks associated with financing. However, it does not provide sufficient data on controlling finances in foreign subsidiaries.

 

Propositions

This section of the report gives propositions for businesses operational in the global environment. These propositions will of the financial context and will be such that they help businesses in overcoming the finance difficulties in international subsidiaries that have been discussed in the literature review section of this report. There are three propositions proposed in this section. These propositions take into account currency fluctuations, low-cost currencies, initial position, political involvement in equity markets, and stable market shares.
The first proposition is to produce semi-complete goods in low-cost countries. The debt-based financing, in this case, should be done by financial debt-based markets in the host country because of the low-interest-rate payments. The debt-based markets include loans from banks, bonds, and securities. According to Madura (2012), the reason is that with low-value currency comes interest payments lower in value as compared to that of countries with highly valued currencies. For countries with higher valued currency, the financing can be attained by these countries with low-valued currency. The other two propositions support this proposition with other contexts of raising finance.
Secondly, in case the country’s currency rates are fluctuating to a high level, the financing should be raised in the host country. According to Williams, Carcello, and Neal (2009), the reason is that raising finance in the host country would reduce the risks associated with currency fluctuation. These risks include raising financing in another country while the host country’s currency value fluctuates, making the financing either greater than the requirements or less than the requirements.
The third proposition is based on the recommendations to subsidiaries that are in their initial stages in host countries. By initial stage, it is meant that the company has not yet developed a stable market share in the country’s industry. The proposition is to raise financing from equity markets if the company is in its initial stages in the country and has not yet gained a stable market share in the country’s industry. The reason is that in initial stages, the company does not have a stable cash flow and market share that guarantees that the company can pay back loans. However, in this case, financing can also be obtained from the parent company or other subsidiaries located in countries with low-value currency. However, in the case of currency value fluctuations, equity markets of the host country should be used. Also, in case the country’s political parties are involved in equity markets, in initial stages, the equity markets should be used even though there might be an option for raising finance from other subsidiaries. This would allow the company to develop a market position.
These propositions are based on the following table:
Activity Appreciation of host country’s currency Depreciation of host country’s currency
Host Country Sales Decrease Increase
Exports in Foreign Currency Decrease Increase
Import of goods in foreign currency Increase Decrease
Interest payments in foreign currency Increase Decrease
Source: Wang (2009)

Application of Propositions

This section of the report is a continuation of the previous section as it discusses the applications of the propositions discussed in the previous section of the report. There are three propositions presented for multinational companies operating in the foreign environment. The application of these three propositions will be discussed systematically which will allow the discussion of all aspects of the proposition.

Low Currency Value Countries

This first proposition is based on the low currency value countries and the advantages that companies can gain out of these countries. According to Branch, loans that are obtained in a foreign currency might also lead to a reduction in financing costs. The interest rates are based on the currency’s base rate that allows multinationals to gain the advantage in the lower-valued currencies (Branch, 2000). At times, countries prefer having a lower valued currency compared to other currencies. The reason is that it helps the countries increase their exports. The proposition given is to produce goods or semi-completed goods in low currency value countries. However, some countries with low-valued currency is a result of the revaluation of the currency. This policy is adopted by countries to boost their trade. However, it is not sustainable over a long period. Therefore, the countries should be chosen on the basis of low-valued currency that is a result of underdeveloped industries (Goldstein & Pevehouse, 2009). Also, the cheap labor force is a characteristic of countries with low-value currency. The reason is that the high value of currency leads to a labor force that demands higher payment because of the goods’ prices being high. In low currency value countries, the goods are cheap, so the labor does not require high salaries to purchase low valued goods. So, the multinational companies should be able to gain two benefits from countries with low valued currencies. One is the low valued production of goods, and the other is low valued loans. However, because of low valued products in these countries, the multinationals should not invest in these countries to offer them the same product at a low cost (Kamal, 2008). In this case, the theory of the purchasing power parity comes into play. In this case, the identical products sold in different countries should have the same value around the world. The reason is that otherwise, the product can be gained from the market that offers the lowest price of the product. Therefore, the markets that have lower priced goods should not be the markets for selling the goods that they produce for sale to other countries. Otherwise, the company would not be able to gain an advantage of the low currency value countries (Wu, 2007). In this case, C. K. Prahalad’s popular ‘Bottom of the Pyramid’ concept is useful for the development of a commodity market for the multinational in such countries.
However, these countries can also be utilized to develop other markets. These markets can also serve to be profitable for multinational companies even though the sale of the products in these low currency valued companies is not a profitable option. Companies can develop products especially for the needs of these countries. The reason is that according to C. K. Prahalad (2010), there exists a fortune at the bottom of the pyramid. By the bottom of the pyramid, the author refers to the poor living conditions and low affordability of the people belonging to this class. For multinational companies, the countries that have low-valued currency have a comparatively lower level of affordability as compared to other countries because of the low price of goods. Smaller packaged goods, and other products that suit the needs of the people can be developed in these countries. The investment in these countries can be of two sorts. The first would be for the development of products for exports to other foreign subsidiaries, and the second would be the development of lower cost goods for sale in the host country.
C.K. Prahalad states that this market is so profitable that if exploited, it will gain the companies tremendous benefits. However, the scope of Prahalad’s research was limited to the poor in a country. If the world is viewed as a country, the countries with cheap labor, therefore low affordability can be regarded as the bottom of the pyramid consumers (Prahalad, 2010).

Fluctuating Currency Rates

The second proposition is related to the problem of highly fluctuating currency rates. The fluctuation of exchange rates presents challenges for companies that are operating in a global context. The reason is that these companies have risks associated with inter-company financial transactions such as loans (IMA, 2012). The level of these fluctuations can be seen in the following chart that shows the fluctuation of the exchange rate of one year consisting of the Euro and the US dollars.

Source: X-Rates (2015)
Also, in this case, the first proposition that suggests raising finance from debt markets of low currency values countries cannot be implemented because of the risks of raising finances that do not fulfil the requirements of the investment. The example by Williams, Carcello, and Neal (2009) stated that raising money in another financial market is risky in the case of currency fluctuations. The reason being that during the raising process, if the currency’s value appreciates against the currency in which the financing is being raised, the total calculated amount required for the investment would raise in terms of the other currency.
The recommendation in the second proposition is to raise financing from the host country for such countries where currency value fluctuates at a greater level compared to an average fluctuation level. Raising finance in the host currency would mean raising financing in the currency that is required for the investment. There would be no loss in the value of the investment that has been raised. However, one difficulty, in this case, is that countries that do not have developed capital markets might not be favorable for the country. This difficulty can be subdued by the government of the country. In a case like these, governments encourage international investors to invest in the capital markets as it positively impacts the economy of the country. This encouragement can be in the form of grants, cheap finance, guaranteed finance, and subsidies. In these countries, therefore, raising investments might be beneficial for the country since raising money would have lesser costs compared to other countries (Ogilvie, 2009).
The variability of exchange rates of the host country can also impact the profitability of the company. In these countries, the trade level should be kept low. If according to the first proposition, products are produced in low currency value countries and exported to countries with volatile exchange rates, the advantage of producing in a country with cheap labor and manufacturing costs cannot be exercised. The company might also suffer from the loss of monetary value in the transactions (Branson, Frenkel, & Goldstein, 2007). So, for the application of these propositions in order to benefit the multinational companies and get them to overcome the financial challenges that they face in global operation, there are some recommendations. The first recommendation is to raise financing in such a country for investment in the same country. Such countries cannot be used for the development of financial subsidiaries because of the volatility of the exchange rates.
However, these currency fluctuations can also result in the company gaining from the appreciation or depreciation of the currency. The appreciation of the currency would result in a lower level of output for the company because of a rise in the real wages. However, a depreciation of the currency would result in a greater level of output gained from a lower level of wages paid (Kwan, 2002). However, the fluctuations would also put a risk on the import of products. If the currency rises in value, the imports will be cheap in terms of the fluctuating currency. If the currency depreciates, the imports will be more expensive to the company. In this case, importing products from other subsidiaries would benefit the parent company. The reason is that the loss of one subsidiary would be the gain of the other. So, in case of fluctuating exchange rates, the multinational company should focus on imports from other subsidiaries and not external parties. Therefore, the countries in which the company bases its manufacturing because of low manufacturing costs should not have a highly volatile exchange rate because it would put a risk on the profitability of the company (Stimpson & Farquharson, 2015).

Initializing a Foreign Subsidiary

The third proposition is based on the financing of the initial operations in a foreign subsidiary. The reason is that the foreign subsidiaries need to raise financing and develop their market share in the host countries. This is the reason that financing decisions are impacted by the same. Also, as a result of the unestablished market share, companies should choose the financing structure carefully because of the cash flow not being consistent for the company. Even though raising financing from the parent company would be an easier option because of already developed financial markets, the new markets should also have visibility to develop a market share.
In order to increase the visibility of the company in foreign markets, multinational companies often resort to raising finance from host country capital markets. Also, for multinational companies, countries have policies that encourage investment. The benefits that are presented for multinational companies for encouraging investment in the country have been discussed previously. The multinational company might raise funds from companies in which there are better and more attractive capital-raising opportunities. Therefore, the companies develop financial subsidiaries in these countries that are not related to the products offered by the company. Multinationals do this to raise financing at lower costs for investing in other subsidiaries. In these cases, political risks are also considered as a factor impacting the decisions to raise financing subsidiaries in a country (Keown, Martin, Petty, & Scott, 2005).
In order to raise financing and decide on the structure for financing, it is required that the companies forecast the cash flows that the foreign subsidiary will be able to achieve. It was recommended in the propositions to opt for equity markets because of greater visibility for the company and reduction of the risk of capital flow. However, the cost of raising equity and maintaining it is more expensive than debt-based financing. The reason is that equity markets have to be paid dividends for as long as the company is listed in the equity market, and the stocks are traded. These dividends are important to raise the value of the company. However, in case of debt financing, the interest rate payments are limited to a time and if paid, do not require further payment as is the case with equity markets (OECD, 2002). One other factor in negative of the equity market is the volatility of the equity markets. It might be that in tight economic conditions, investors pull money from the equity markets reducing the stock value and bringing loss for the company (Freeman, 2003)
In order to minimize financing costs, the company should forecast cash flows to decide on the amount that can be gained from loans. The other amount can be generated from the equity markets of the country. However, as mentioned previously, the presence in an equity market is very important for companies to gain market shares. Also, the subsidies and advantages given to foreign companies should be assessed in order to determine the level of financing that would be beneficial for the company to obtain from equity markets (Madura, 2015). The loans can be taken from the parent company to reduce the costs of loans. This includes raising the interest rates on a high to reduce the costs of taxes on the profits of the company. However, if the company is utilizing a mix of debt from the parent company and the equity market, the loan, even if it is from the parent company, should be assessed for its value. This value should be assessed from the cash flow forecasts. The reason is that a company in a high level of loans would be unattractive to investors in the equity markets if the cash flow is not high. The reason is that debt instruments are prioritized and limit the level of dividends given out to the investors. Therefore, the multinational companies should determine a level of debt and equity financing that minimizes the costs and increases the value of the company as well (Cahill, 2013).

Conclusion

This paper included the assessment of the challenges that multinational companies face in operating in foreign countries. These challenges were the financial challenges and risks that the company faces. From these challenges, three propositions were derived that were suggestions for multinational companies to reduce the element of risks and costs in financing operations internationally. The main problem identified in the literature review section of the report was the differences in exchange rates. These propositions each included an element of exchange rate risks including the risk of fluctuations, low and high-valued currency. The propositions were made such that they reduced the risks of exchange rates and increased the benefit obtained from the value of the currencies.
The first proposition was related to gaining the advantage from countries with low-value currencies. There were two recommendations made in this case. The first recommendation was to increase the level of manufacturing of products in these countries for supplying to other countries. The reason given for this was the cheap labor and manufacturing costs in these countries. The second recommendation was based on the popular ‘bottom of the pyramid’ concept introduced by C. K. Prahalad to exploit the opportunities in these countries. This concept, combined with the purchasing power parity concept led to the recommendation that the products manufactured at a low-cost in these countries should not be sold at a low cost in these countries because it will lead the company to a disadvantage. A new market of products should be developed in these countries catering to their needs and in line with the company’s profitability objectives.
The second proposition was related to the challenge presented because of fluctuating exchange rates. The recommendation was that the country be not chosen for the development of financial subsidiaries for obtaining financing for other subsidiaries. In this case, the imports should not be sourced from external parties, but other subsidiaries to benefit the parent company at a whole. Also, the suggestion was made to raise financing for projects in the country in the country’s financial markets if they are established or offer advantages for the company.
The third proposition was related to the financing decisions at the initial stages of development in a foreign market. The reason this was regarded as a different proposition was the impact of the financing decisions on the company’s market share in the country. The recommendation was made to determine the ratio of debt to equity in such a country. The reason given was that a high level of debt can put off investors, and a high level of equity can increase the financing costs for the company. Initially, the company must forecast the level of cash flows that it will generate and then decide on the percentage of debt. Presence in equity markets was also deemed important in the visibility of the company, therefore, the development of a significant market share in the country.

References

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