Chapter 16 Global Trends in FDI Foreign direct investment often by xiuliliaofz

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									Chapter 16
Global Trends in FDI
   Foreign direct investment often involves the
    establishment of production facilities abroad.
   Greenfield investment involves building new facilities
    from the ground up.
   Cross-border acquisition involves the purchase of an
    existing business.


Most world-wide FDI comes from the developed world.
 This implies that MNCs domiciled in these countries should
  have certain comparative advantages in undertaking
  overseas investment projects.
 Both developing and developed nations are the recipient
  of inflows of FDI.
    – Some developing countries, like China and Mexico,
      have begun to undertake FDI, albeit on a modest
      scale.




                                                             1
Average Annual FDI (in USD b) 2004-2008




                                                                                                                                  212.3
      250




                                                                                                                               188.9
                                                     Inflows
      200




                                   148.8
                                                     Outflows




                                                                                                                       137.2
                                                                                                                      129.6
      150




                                             106.7
                                      93.5
                            79.5




                                                                                            75.1
      100




                                                                65.7



                                                                                   64.2




                                                                                                             58.5
                   51.8
                   48.3




                                                         47.6




                                                                                              36.1
                                                                                     33.2


                                                                                                      29.4
                                                      26.7




                                                                                                     22.9
                          22.7




                                                                            22.1
                                                33




                                                                                                               19.5
       50
              24
            10.8




                                                                  10.2
                                                                         5.1
        0




Why Do Firms Invest Overseas?
 Trade barriers
     Tariffs, quotas, and other restrictions on the free flow
      of goods, services, and people.
     Trade barriers from high transportation costs,
      particularly for low value-to-weight goods.
 Intangible assets
     Coca-Cola has a very valuable asset in its closely
      guarded “secret formula.”
     To protect that proprietary information, Coca-Cola
      has chosen FDI over licensing.


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 Vertical integration
     MNCs may undertake FDI in countries where inputs
      are available in order to secure the supply of inputs at
      a stable accounting price.
     Vertical integration may be backward or forward:
          Backward: e.g., a furniture maker buying a
           logging company.
          Forward: e.g., a U.S. auto maker buying a
           Japanese auto dealership.
 Labor market imperfections
     Among all factor markets, the labor market is the
      least perfect.
     If there exist restrictions on the flow of workers
      across borders, then labor services can be
      underpriced relative to productivity. The restrictions
      may be immigration barriers or simply social
      preferences.




                                                               3
Labor Costs around the Globe (2008)
                 Average Hourly                     Average Hourly
  Country        Cost ($)           Country         Cost ($)
  Germany        $41.46               Spain         $23.61
  Belgium        $39.22               Korea         $13.82
  Sweden         $38.08               Israel        $13.91
  U.K.           $28.22               Taiwan        $6.95
  Australia      $31.51               Hong Kong     $5.78

  Canada         $29.72               Brazil        $5.96
  France         $31.60               Mexico        $2.93
  U.S.           $25.33               Philippines   $1.10
  Japan          $22.90               China         $0.81



Cross-Border Mergers & Acquisitions
   Greenfield investment -- Building new facilities from the
    ground up.
   Cross-border acquisition
          – Purchase of existing business.
          – Represents 40-50% of FDI flows.
Cross-border acquisitions are a politically sensitive issue and
are often unwelcome, whereas Greenfield investment is usually
welcome.

                                                                     4
Political Risk and FDI -- The biggest risk when investing abroad.
   “Does the foreign government uphold the rule of law?”A
    big source of risk is the non-enforcement of contracts.
        Uncertainty regarding cross-border flows of capital.
        Uncertainty regarding the host country’s policies on a
         firm’s operations.
        Uncertainty regarding expropriation.


Measuring Political Risk
   The host country’s political and government system
       – A country with too many political parties and
         frequent changes of government is risky.
   Integration into the world system
       – North Korea and Iran are examples of isolationist
         countries unlikely to observe the “rules of the game.”
   Ethnic and religious stability
   Is there religious and ethnic turmoil
   Regional security
       – Kuwait is a nice enough country, but it’s in a rough
         neighborhood.
                                                                    5
   Key economic indicators
       – Severe income inequality and deteriorating living
         standards can cause major political disruptions.
       – In 2002, Argentina’s protracted economic recession
         led to the freezing of bank deposits, street riots, and
         three changes of the country’s presidency in as many
         months.


Hedging Political Risk
   Geographic diversification -- Simply put, don’t put all your
    eggs in one basket.
   Minimize exposure --
       – Form joint ventures with local companies. Local
         government may be less inclined to expropriate
         assets from their own citizens.
       – Join a consortium of international companies to
         undertake FDI. Local government may be less
         inclined to expropriate assets from a variety of
         countries all at once.
   Finance projects with local borrowing.



                                                                   6
Chapter 17


  Cost of Capital
   The cost of capital is the minimum rate of return an
    investment project must generate in order to pay its
    financing costs.
   For a levered firm, the financing costs can be represented
    by the weighted average cost of capital:


  WACC = (%E)rk + (%D)rd(1-tc)


   A firm that can reduce its cost of capital will increase the
    profitable capital expenditures that the firm can take on
    and increase the wealth of the shareholders.




                                                                   7
Firms might be able to reduce their cost of capital by Cross-
Border Listings of Stocks
   Cross-border listings of stocks benefit a company:
       – Cross-listing creates a secondary market for the
         company’s shares, which facilitates raising new
         capital in foreign markets and lowering the cost of
         capital.
       – Cross-listing can enhance the liquidity of the
         company’s stock.
       – Cross-listing enhances the visibility of the company’s
         name and its products in foreign marketplaces.


   Cross-border listings of stocks do carry costs:
       – It can be costly to meet the disclosure and listing
         requirements imposed by the foreign exchange and
         regulatory authorities.
       – Once a company’s stock is traded in overseas
         markets, there can be volatility spillover from these
         markets.
   On average, cross-border listings of stocks appears to be a
    profitable decision, the benefits outweigh the costs.


                                                                  8
Chapter 18
Review of Domestic Capital Budgeting
   Identify the size and timing of all relevant cash flows on a
    time line.
   Identify the riskiness of the cash flows to determine the
    appropriate discount rate.
   Find NPV by discounting the cash flows at the appropriate
    discount rate.


                                                                   9
The basic net present value equation is
                 T
                          CFt       TVT
           NPV                           C0
                 t 1   (1  K ) (1  K )T
                                t




Where:
 CFt   = expected incremental after-tax cash flow in year t
 TVT = expected after-tax terminal value including return
of net working capital
 C0    = initial investment at inception
  K    = weighted average cost of capital
  T    = economic life of the project in years

The NPV rule is to accept a project if NPV  0




                                                              10
There are two approaches for capital budgeting in an
international setting.
   (Home currency approach):
       – Estimate future cash flows in foreign currency.
       – Convert to the home currency at the predicted
         exchange rate.
       – Calculate NPV using the home currency cost of
         capital.


   (Foreign currency approach):
       – Estimate future cash flows in the foreign currency.
       – Estimate the foreign currency discount rate.
       – Calculate the foreign currency NPV using the foreign
         cost of capital.
  Translate the foreign currency NPV into dollars using the spot
  exchange rate.
   If you watch your rounding, you will get exactly the same
    answer either way.




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An example: Suppose a US company is considering investing in a
European project that costs 2 million Euros and will generate .9
million Euros for 3 years. The spot rate is .5 euros/dollar. The US
risk free rate is 5%, and the Europe risk free rate is 7%. The required
rate of return in US is 10%. Use both the foreign currency approach
and the home currency approach to solve this problem.

Home currency approach




Foreign currency approach




                                                                     12
Another Example -- Your company is looking at a new project in
Mexico. The project will cost 9 million pesos. The cash flows are
expected to be 2.25 million pesos per year for 5 years. The current
spot exchange rate is 9.08 pesos per dollar. The risk-free rate in the
US is 4%, and the risk-free rate in Mexico 8%. The dollar required
return is 15%.

Home currency approach




Foreign currency approach




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