International Financial Management

Jeff Madura

Chapter 15 International Corporate Governance and Control - all with Video Answers

Educators

Chapter Questions

Problem 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?

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01:05

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?

Niamat Khuda

Numerade Educator

Problem 3

Global Expansion Strategy Poki, Inc., a
U.S.-based MNC, is considering expanding into
Thailand because of decreasing profit margins in the United States. 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?

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Problem 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 acquires a private target in Russia, will it be able to avoid the impact of the high stock prices on business valuations in Russia?

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Problem 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 tablets. 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?

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Problem 6

Privatized Business Valuations Why are valuations of privatized businesses previously owned by the governments of developing countries more difficult than valuations of existing firms in developed countries?

Rashmi Sinha

Numerade Educator

Problem 7

Valuing a Foreign Target Blore, Inc., a U.S.based MNC, has screened several targets. Based on economic and political considerations, only one eligible target remains in Malaysia. Blore would like you to value this target and has provided the following information:
E Blore expects to keep the target for three years, at which time it expects to sell the firm for 300 million Malaysian ringgit (MYR) after any taxes.
- Blore expects a strong Malaysian economy. The estimates for revenue for the next year are MYR200 million. Revenues are expected to increase by 8 percent in each of the following two years.
II Cost of goods sold is expected to be 50 percent of revenue.
- Selling and administrative expenses are expected to be MYR30 million in each of the next three years.
= The Malaysian tax rate on the target's earnings is expected to be 35 percent.
- Depreciation expenses are expected to be MYR20 million per year for each of the next three years.
- The target will need MYR7 million in cash each year to support its existing operations.
- The target's stock price is currently MYR 30 per share. The target has 9 million shares outstanding.
- Any remaining cash flows will be remitted by the target to Blore, Inc. Blore uses the prevailing exchange rate of the Malaysian ringgit as the expected exchange rate for the next three years. This exchange rate is currently $$\$ 0.25$$.
= Blore's required rate of return on similar projects is 20 percent.
a. Prepare a worksheet to estimate the value of the Malaysian target based on the information provided.
b. Will Blore, Inc., be able to acquire the Malaysian target for a price lower than its valuation of the target?

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Problem 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 if Asia experienced a new economic crisis.

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Problem 9

Divestiture Strategy A crisis in a foreign country commonly causes a substantial reduction in cash flows (and valuations) of an MNC's subsidiaries based in that country. Explain why the MNC will not necessarily sell its subsidiaries even if these subsidiaries are not profitable.

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Problem 10

Why a Foreign Acquisition May Backfire Provide two reasons why an MNC's strategy of acquiring a foreign target could backfire. That is, explain why the acquisition might result in a negative NPV.

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03:59

Problem 11

Pricing a Foreign Target Alaska, Inc., would like to acquire Estoya Corp, which is located in Peru. In initial negotiations, Estoya has asked for a purchase price of 1 billion Peruvian new sol. If Alaska completes the purchase, it would keep Estoya's operations for two years and then sell the company. In the recent past, Estoya has generated annual cash flows of 500 million new sol per year, but Alaska believes that it can increase these cash flows 5 percent each year by improving the Peruvian plant's operations. Given these improvements, Alaska believes it will be able to resell Estoya in two years for 1.2 billion new sol. The current exchange rate of the new sol is $$\$ 0.29$$, and exchange rate forecasts for the next two years indicate values of $$\$ 0.29$$ and $$\$ 0.27$$, respectively. Given these facts, should Alaska, Inc., pay 1 billion new sol for Estoya Corp, if the required rate of return is 18 percent? What is the maximum price that Alaska should be willing to pay?

Daniel Cisneros

Numerade Educator

Problem 12

Global Strategy Senser Co, established a subsidiary in Russia two years ago. Under its original plans, Senser intended to operate the subsidiary for a total of four years. However, it would like to reas sess the situation because exchange rate forecasts for the Russian ruble now indicate that it may depreciate from its current level of $$\$ 0.033$$ to $$\$ 0.028$$ next year and to $$\$ 0.025$$ 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 United States. The required rate of return of the project is 16 percent. Should Senser continue operating the Russian subsidiary?

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Problem 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?

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09:17

Problem 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.

Narayan Hari

Numerade Educator

Problem 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 United States, 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 attacks as opposed to before the attacks? Describe the general method for determining whether the divestiture is financially feasible.

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Problem 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 for $$\$ 60$$ million in cash, and the offer is still available this week. The annualized long-term risk-free rate in the United States increased from 7 to 8 percent this week. The monthly cash flows expected to be generated by the subsidiary have not changed since last week. The risk premium that Merton applies to its projects in Bulgaria was reduced from 11.3 percent to 10.9 percent this week. The annualized long-term risk-free rate in Bulgaria declined from 23 percent to 21 percent 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.)

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Problem 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 will approve the acquisition only if Sunbelt agrees not to 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?

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Problem 18

Foreign Acquisition Decision Florida Co. produces software. Its primary business in Boca Raton is expected to generate cash flows of $$\$ 4$$ million at the end of each of the next three years, and Florida expects that it could sell this business for $$\$ 10$$ million (after accounting for capital gains taxes) at the end of three years. Florida Co. also has a side business in Pompano Beach that takes the software created in Boca Raton and distributes it in Europe. As long as the side business distributes this software in 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 Ryne Co., located 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 Co.'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. 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 percent. 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 because they were already taxed in Europe. The spot rate of the euro is $\$ 1.10$, and Florida $\mathrm{Co}$. 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 three years for 3 million euros (after accounting for any capital gains taxes). Florida Co,'s required rate of return on the acquisition is 20 percent. Determine the net present value of this acquisition. Should Florida Co. acquire Ryne Co.?

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Problem 19

Foreign Acquisition Decision Idaho
Co. consists of two businesses. Its local business is expected to generate cash flows of $$\$ 1$$ million at the end of each of the next three years. It also owns a foreign subsidiary based in Mexico, whose business is selling technology in Mexico. This business is expected to generate $$\$ 2$$ million in cash flows at the end of each of the next three years. The main competitor of the Mexican subsidiary is Perez $\mathrm{Co}_*$, a privately
held firm that is based in Mexico. Idaho Co, just contacted Perez Co. and wants to acquire it. If it acquires Perez, Idaho would merge Perez's operations with its Mexican subsidiary's business. The merged operations in Mexico would be expected to generate a total of $$\$ 3$$ million in cash flows at the end of each of the next three years. Perez $\mathrm{Co}$, is willing to be acquired for a price of 40 million pesos. The spot rate of the Mexican peso is $$\$ 0.10$$. The required rate of return on this project is 24 percent. Determine the net present value of this acquisition by Idaho $\mathrm{Co}$. Should the company pursue this acquisition?

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Problem 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 $\mathrm{Co}$. 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 two years from now. Venice Co. is meeting with Kentucky Co. today to negotiate the acquisition price that it will pay for Kentucky's subsidiary in two years. If Kentucky Co. retains the business for the next two years, it expects that the business will 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 United States. The euro is presently valued at $$\$ 1.20$$, and that rate can be used as a forecast of future spot rates. Kentucky would retain the business if it could earn a rate of return of at least 18 percent 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. to satisfy its required rate of return.

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Problem 21

Foreign Divestiture Decision Baltimore Co. considers divesting its six 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?
(FIGURE CAN'T COPY)

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Problem 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.
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 than, smaller than, 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 United States has declined. Will the NPV of the divestiture be larger than, smaller than, or the same as it was last week? Briefly explain.

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Problem 23

Impact of Country Perspective on Target Valuation Targ Co. of the United States has been targeted by three firms that consider acquiring it: Americo (from the United States), Japino (of Japan), and Canzo (of Canada). These three firms do not have any other international business, have similar risk levels, and have a similar capital structure. Each of the three potential acquirers has derived similar expected dollar cash flow estimates for Targ Co. The long-term risk-free interest rate is 6 percent in the United States, 9 percent in Canada, and 3 percent 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 $\mathrm{Co}$. 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.

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Problem 24

Valuation of a Foreign Target Gaston $\mathrm{Co}$. (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 $$\$ 0.14$$, and the expected spot rate in one year is $$\$ 0.12$$. 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.

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Problem 25

Divestiture of a Foreign Subsidiary Rudecki Co. (a U.S. firm) has a Polish subsidiary that it is considering divesting. The 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 sold solely in the United States and 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 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.)

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03:06

Problem 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.

Madi Sousa

Numerade Educator

01:27

Problem 27

Governance of MNCs by Shareholders Explain the various ways in which large shareholders can attempt to govern an MNC and improve its management.

Kaylee Mcclellan

Numerade Educator

Problem 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 $\mathrm{Co}$. 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 United States suddenly declines and all other factors are unchanged, will the NPV of the divestiture be larger than, smaller than, or the same as it was last week? Briefly explain.

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Problem 29

Valuation of a Planned Divestiture Dallen $\mathrm{Co}$. has a subsidiary in Mexico that does research and development and produces prescription pills that are transported to and sold in the United States. 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 United States is denominated in dollars. It has no other international business. Dallen's competitors are local firms in the United States 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 United States 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.

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Problem 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 $\operatorname{tax}$ on the sale.
a. Should Kylee Co, sell the business? Show your work.
b. Assume that news reports today cause 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 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.

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