SBM Chapter -16
International trading 1
Overseas investments 2
Financing overseas investments 3
Exchange controls 4
Dividend management 5
Transfer pricing 6
1.1
Trade risks
Loss or damage in transit
Faults with product
1.2 Credit risks: Customer will not pay. There are a
number of method of reducing the risks of bad debts in foreign trade.
* Export factoring *
Forfaiting * Documentary credits
* Export credit insurance * Export merchants *Government department
1.3
Financing trading: When
making decisions about international financing, company should consider:
- The need for financing
- The length of time of financed
- The cost of different methods of
financing
- The risk associated with
financing the transaction.
- The need for pre and post export
working capital.
1.4 Foreign exchange risk
management: The following different types of foreign exchange
risks may be significant:
Transaction risks: The
risk of adverse exchange rate movements occurring in the international trading
transactions.
Economic risks: The
risk that exchange rate movements might reduce the international competitiveness
of a company. It is the risk that present value of a company’s future cash
flows might be reduced by adverse exchange rate movement.
Translation risks: The risk that the organization will make exchange losses
when the assets and liabilities of its foreign branches or subsidiaries are
translated into the home currency.
IAS 21 The Effects of Changes in Foreign Exchange Rates, at the year-end
monetary assets and liabilities on the statement of financial position are
retranslated at the closing rate on the accounting date. Non-monetary items
(non-current assets, inventory and investments) are not retranslated.
2.
Overseas investment:
Takeover or merger : If speed of entry into the overseas market is a
high priority then acquisition may be preferable than others. The main problem
is that the better acquisitions may only be available at a premium.
Advantages of takeovers/mergers
(a) Purchasing market information, market
share, distribution channels and reputation.
(b) Other
synergies
(c) Acquiring a subsidiary may be a means of removing trade barriers.
(d) Start-up costs will not be incurred.
Disadvantages of takeovers/mergers
(a) Cultural issues
(b) Growing organically may be cheape
Overseas subsidiaries: The basic
structure of many MNCs consists of a parent (holding) company with subsidiaries
in several countries..
Branches
Advantages of branches
(a) Establishment of a branch is likely to be simpler than a subsidiary.
(b) In many countries, the remitted profits of a subsidiary taxed at a higher rate than a branch,
Disadvantages of branches
(a) The parent company is fully liable for the
liabilities of the branch.
(b) Banks and clients prefer dealing with a local company rather than branch of foreign company.
Joint ventures: is the commitment for a duration of
for sharing funds, facilities and services by two or more legally separate
enterprise for their mutual benefit.
Advantages of international joint venture
(a) It gives relatively low cost access to
markets in new countries.
(c) The joint venture partner's
existing local knowledge, cultural
awareness, distribution network
and marketing or other skills can be used.
Disadvantages of international joint venture
(a) Managerial freedom may be restricted
Interactive question 1: International investment
decisions: Tiger Electronics – a specialist
manufacturer of electronic spare parts of a major car manufacturer – is
considering direct investments in several African countries. Business is
currently booming and Tiger is very keen to take advantage of the low cost
resources in Africa. However, Tiger's board of directors is concerned about the
potential effects of political and economic volatility in various African
countries on production of spare parts and supply of necessary resources.
Requirements
(a) Discuss factors that Tiger should take into
consideration when deciding which, if any, African countries it should invest
in.
(b) How might Tiger handle political risk if it invested
in Africa?
(c) What ethical issues might have to be taken into
consideration as part of Tiger's overall overseas investment strategy?
Answer to Interactive question 1
(a) Tiger should consider such issues as:
(i)
Convertibility
of currency
(ii)
Availability
of other suitable resources:
(iii)
Inflation
and economic stability:
(iv)
Cultural
compatibility
(b) Minimisation
of political risks: To following steps to minimise the
effects of political risk.
Negotiations with host government
Insurance
Financing structure
Ownership structure
(c)
i) Provision of proper safety equipment and working conditions for
employees
ii) Use of child labour
iii) Wage rates below subsistence level
iv) Discrimination against women
v) Pollution of the environment
3
Financing overseas investments
3.1 Factors
affecting the capital structure of an MNC
Global taxation Exchange
risk Political risk Business risks Finance risk:
3.2
Borrowing internationally
·
Availability
·
Lower
cost of borrowing
·
Lower
issue costs
3.5.1 Accounting for hedging of net investments: Hedges of a net investment in a foreign operation should
be accounted in a similar way to cash flow hedges, that is:
The portion of
gain or loss on the hedging instrument that is determined to be an effective hedge should
be recognised in other comprehensive income; and
The ineffective portion should be recognised in profit or loss.
The gain or loss on the hedging instrument that has been
recognised in other comprehensive income should be reclassified to profit or loss on disposal of
the foreign operation. If only
part of an interest in a foreign operation is disposed of, only the relevant
proportion of this gain or loss should be reclassified to profit or loss.
3.7 Global treasury management: N/A
Interactive question 2:
Overseas investment VVI
4
Exchange controls
Rationing
the supply of foreign exchange.
Restricting
the types of transaction
Worked example: Remittance restrictions: Flagwaver Inc, a US company, is considering whether to
establish a subsidiary in Aspavia, where the currency is the E, at a cost of
E20,000,000. The subsidiary will run for four years and the net cash flows from
the project are shown below.
Net cash flow
E
Year 1 3,600,000
Year 2 4,560,000
Year 3 8,400,000
Year 4 8,480,000
There is a withholding tax of 10% on remitted profits
and the exchange rate is expected to remain constant at $1 = E1.50. At the end
of the four-year period the Aspavian government will buy the plant for
E12,000,000. The latter amount can be repatriated free of withholding taxes.
Requirements
(a) If the required rate of return is 15% calculate the
present value of the project.
Now assume that no funds can be repatriated for the
first three years, but all the funds are allowed to be remitted to the home
market in year 4. The funds can be invested at a rate of 5% per year.
(b) Assess whether the project is still financially
viable.
4.3 Strategies for dealing
with exchange control
Transfer
pricing
Royalty
payments
Loans by
the parent company to the subsidiary.
Management
charges
5 Dividend management: The
amount of dividends foreign subsidiaries pay to the parent company depend on
the parent company's dividend policy, financing needs, taxation and managerial
control.
6
Transfer price is the
price at which goods or services are transferred from one process or department
to another or from one member of a Group to another.
6.4 Factors affecting transfer
pricing
·
Performance evaluation
·
Management incentives
·
Cost allocation
·
Taxes
·
Tariffs
·
Exchange control and quotas
The arm's length standard has two methods.
Method 1: use the price negotiated between two unrelated parties C
and D to proxy for the transfer between A and B.
Method 2: use the price at which A sells to unrelated party C to
proxy for the transfer price between A and B.
The main methods of establishing 'arm's length' transfer prices of
tangible goods include:
The
comparable uncontrolled price method
The
resale price method:
The
cost plus method:
The
comparable profit method
The
profit split method
Interactive
question 3: Transfer pricing : An MNC based in Beeland has
subsidiary companies in Ceeland and in the UK. The UK subsidiary manufactures
machinery parts which are sold to the Ceeland subsidiary for a unit price of
B$420 (420 Beeland dollars), where the parts are assembled. The UK subsidiary
shows a profit of B$80 per unit;
200,000 units are sold annually.
The Ceeland subsidiary incurs further costs of B$400 per unit and sells
the finished goods on for an equivalent of B$1,050.
All of the profits from the foreign subsidiaries are remitted to the
parent company as dividends. Double taxation treaties between Beeland, Ceeland
and the UK allow companies to set foreign tax liabilities against their
domestic tax liability.
The following rates of taxation apply.
UK Beeland Ceeland
Tax on company profits 25%
35% 40%
Withholding tax on dividends – 12%
10%
Requirements
Show the tax effect of increasing the transfer price between the UK and
Ceeland subsidiaries by 25%.
Self Test
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