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- 6 Marks
Question
KK Chemicals Ltd, an Accra-based manufacturer of paints, sells its products only in Ghana. Currently, the company wants to expand into other African countries. The directors are considering two options: setting up its own subsidiary company to manufacture and sell the products or licensing a company based in the host country to manufacture and sell the products.
Required:
i) Advise the directors on TWO potential advantages and TWO disadvantages to KK Chemicals of setting up its own subsidiary company to handle production and sale in the host country as against licensing a company in the host country. (4 marks)
ii) Suppose KK Chemicals elects to set up a subsidiary in the host country. Suggest to the directors TWO ways of dealing with the risk of blocked funds. (2 marks)
Answer
i) Advantages and disadvantages of setting up a subsidiary versus licensing:
Advantages of setting up a subsidiary:
- Control over operations: KK Chemicals will have full control over production processes and product quality, avoiding potential issues that could arise from licensing.
- Full earnings retention: The company will retain all profits from sales rather than sharing them with a licensee through royalties.
Disadvantages of setting up a subsidiary:
- Higher financial commitment: Setting up a subsidiary requires substantial capital investment, which could limit available resources for other projects or force the company to take on debt.
- Exposure to political risks: A subsidiary is more exposed to political risks such as expropriation, business interruption, or currency restrictions in the host country.
(4 marks)
ii) Ways to mitigate blocked funds risk:
Blocked funds occur when a host country’s government restricts the repatriation of profits. KK Chemicals can deal with blocked funds by:
- Intra-company transactions: Sell goods or services to the subsidiary, ensuring payment is made to the parent company.
- Royalties and fees: Charge the subsidiary royalties for using KK Chemicals’ intellectual property or management services fees, which can be remitted to the parent company.
- Offer management services to the subsidiary for a fee.
- Give more loan (rather than equity) finance to the subsidiary for interest payment.
- Topic: International investment and financing decisions
- Series: NOV 2016
- Uploader: Joseph