Topic: Economic environment for multinational organisations

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  • 10 Marks

AFM – Nov 2017 – L3 – Q4a – Economic environment for multinational organizations

Discusses five ways in which government action can affect the decision-making role of a finance manager.

The economic environment within which the Financial Manager must operate is subject to a variety of influences, one of which is from the government.

Required:
Explain FIVE areas in which government action might affect the problem-solving and decision-making roles of a Finance Manager. (10 marks)

Government action can significantly impact the financial decision-making process in the following five areas:

  1. Credit Controls:
    Governments can impose credit restrictions through central banks, limiting the amount of credit available to businesses. This increases the cost of borrowing and makes financing options more challenging, which affects liquidity management and capital expenditure planning.
  2. Taxation Policies:
    Changes in corporate tax rates, sales tax, withholding tax, and capital allowances can influence cash flow, profitability, and the overall cost of operations. Finance managers must account for these when making investment decisions or determining dividend policies.
  3. Custom Duties and Trade Tariffs:
    Governments may introduce or adjust custom duties and tariffs on imports and exports. High tariffs can increase production costs if the company relies on imported raw materials, while export restrictions could limit market expansion opportunities.
  4. Exchange Rate Controls:
    Governments can control exchange rates or impose restrictions on the use of foreign currencies. For multinational firms, this affects currency risk management, profit repatriation, and the cost of international transactions.
  5. Price and Wage Controls:
    Government-imposed limits on prices or wages can affect a company’s profitability by restricting the ability to pass on cost increases to consumers or reduce costs through wage adjustments. This forces finance managers to find other ways to optimize costs and maintain financial stability.
  • 10 Marks

AFM – May 2019 – L3 – Q1a – Economic environment for multinational organisations

Compare joint ventures and licensing for foreign expansion and explain five strategic reasons for a firm to engage in FDI.

“Oil-rich Ghana’s sovereign wealth fund Ghana Development Board (GDB) has already invested in a number of real estate and infrastructure projects around the world, including a $2.5 billion joint venture with Petro Nigeria Ltd and a scheme to create a carbon-neutral city in Ghana”.

Required:

i) Compare the use of joint ventures as opposed to licensing for GDB if it wishes to expand abroad and outline the advantages and disadvantages of both joint ventures and licensing. (5 marks)

ii) Explain FIVE (5) strategic reasons for Foreign Direct Investment (FDI), for a firm wishing to expand. (5 marks)

i) Comparison of Joint Ventures and Licensing

Joint Ventures
There are two distinct types of joint ventures: industrial co-operation (contractual) and joint-equity. A contractual joint venture is for a fixed period, and the duties and responsibilities of the parties are contractually defined. A joint-equity venture involves investment, is of no fixed duration, and continually evolves. Depending on government regulations, joint ventures may be the only means of access to a particular market.
(0.5 mark)

Licensing
Licensing is an alternative to FDI. It involves conferring rights to make use of the licensor company’s production process to producers located in the overseas market in return for royalty payments.
(0.5 mark)

Advantages of Joint Ventures

  • Relatively low-cost access to new markets
  • Easier access to local capital markets, possibly with accompanying tax incentives or grants
  • Use of the joint venture partner’s existing management expertise, local knowledge, distribution network, technology, brands, patents, and marketing or other skills
  • Sharing of risks
  • Sharing of costs, providing economies of scale

(2 points @ 0.5 marks = 1 mark)

Disadvantages of Joint Ventures

  • Managerial freedom may be restricted by the need to take account of the views of all the joint venture partners
  • There may be problems in agreeing on partners’ percentage ownership, transfer prices, reinvestment decisions, nationality of key personnel, remuneration, and sourcing of raw materials and components
  • Finding a reliable joint venture partner may take a long time
  • Joint ventures are difficult to value, particularly where one or more partners have made intangible contributions

(2 points @ 0.5 marks = 1 mark)

Advantages of Licensing

  • It can allow fairly rapid penetration of overseas markets
  • It does not require substantial financial resources
  • Political risks are reduced since the licensee is likely to be a local company
  • Licensing may be a possibility where direct investment is restricted or prevented by a country
  • For a multinational company, licensing agreements provide a way for funds to be remitted to the parent company in the form of license fees

(2 points @ 0.5 marks = 1 mark)

Disadvantages of Licensing

  • The arrangement may give the licensee know-how and technology, which it can use in competing with the licensor after the license agreement has expired
  • It may be more difficult to maintain quality standards, and lower quality might affect the standing of a brand name in international markets

(2 points @ 0.5 marks = 1 mark)

ii) Strategic Reasons for Foreign Direct Investment (FDI)

  1. Market Seeking
    Firms engage in FDI to meet local demand or as a way of exporting to other markets. For example, the manufacturing operations of US and Japanese car producers in Europe.
    (1 mark)
  2. Raw Material Seeking
    Firms in industries such as oil, mining, plantation, and forestry extract raw materials in locations where they are found, whether for export or further processing and sale in the host country.
    (1 mark)
  3. Production Efficiency Seeking
    Companies engage in FDI to take advantage of production efficiencies, such as cheap labor or other factors of production, like in Taiwan and Malaysia’s electronics industries.
    (1 mark)
  4. Knowledge Seeking
    Some firms seek FDI to gain access to technology or management expertise, as seen in the acquisition of US-based electronics companies by German, Japanese, and Dutch companies.
    (1 mark)
  5. Political Safety Seeking
    Firms may invest in countries perceived to offer political stability and protection from expropriation or interference with private enterprise.
    (1 mark)
  • 20 Marks

AFM – Nov 2018 – L3 – Q1b – Economic environment for multinational organisations

Advising One-Village on the risks associated with a proposed irrigation project in a Sub-Saharan African country based on the World Bank Doing Business Report.

The directors of One-Village are considering another irrigation project in a country in Sub-Saharan Africa. The World Bank’s Doing Business Report for 2017 ranked the destination country 140th out of 190 countries on the ease of doing business. Below is the ease of doing business statistics for the destination country and One-Village’s home country as reported in the Doing Business 2017 report.


Required:
Advise the directors on four risks or issues One-Village should consider when deciding on whether to implement the proposed irrigation project in the destination country, and suggest how the risks or issues may be mitigated or resolved.
(8 marks for risks and mitigation)

Identified Risks and Issues:

  1. Dealing with Construction Permits:
    • The destination country ranks 174th for dealing with construction permits with a score of 49.63, compared to One-Village’s home country at rank 117 with a score of 65.34. This indicates potential delays or additional bureaucratic hurdles in obtaining permits for the irrigation project.
    • Mitigation: One-Village should engage local legal and regulatory experts early in the process to navigate the bureaucratic requirements efficiently and ensure all paperwork and procedures are completed in a timely manner.
  2. Getting Electricity:
    • The destination country ranks 180th with a low score of 29.43 for getting electricity, compared to One-Village’s home country’s rank of 120 (60.30 score). This suggests significant challenges in accessing reliable electricity, which could hinder the operation of irrigation equipment.
    • Mitigation: One-Village could consider alternative energy sources, such as solar or wind power, to reduce reliance on the national grid. Additionally, partnerships with local authorities or infrastructure providers could be explored to secure priority access to electricity.
  3. Paying Taxes:
    • The destination country ranks very low (182nd) with a score of 28.09 in terms of paying taxes, compared to One-Village’s home country rank of 122 (62.91 score). This implies potential issues with tax compliance, high tax rates, or complex tax procedures in the destination country.
    • Mitigation: One-Village should hire tax consultants familiar with the local tax regime to ensure compliance and explore tax incentives or exemptions for agricultural projects, which may be available in the destination country.
  4. Trading Across Borders:
    • With a rank of 181 and a low score of 19.93 in trading across borders, compared to One-Village’s home country rank of 154 (52.32 score), this indicates potential difficulties in importing necessary materials or exporting agricultural products due to inefficient border controls, customs delays, or restrictive trade policies.
    • Mitigation: One-Village should engage in advance planning for supply chain management, including identifying reliable local suppliers or negotiating favorable terms with customs brokers. Understanding and planning for potential delays in shipping and customs clearance is essential.

Overall Discussion:

The rankings and scores highlight potential risks related to bureaucracy, infrastructure, tax compliance, and cross-border trade in the destination country. One-Village should carefully assess the project feasibility in light of these risks and develop comprehensive risk management strategies, including forming local partnerships, conducting due diligence on regulatory requirements, and exploring alternative solutions to infrastructure challenges. Engaging local experts and leveraging government incentives could also help mitigate the identified risks.

  • 5 Marks

AFM – May 2016 – L3 – Q4b – International investment and financing decisions, Economic environment for multinational organizations

Describe five strategic reasons that might motivate a company to undertake foreign direct investment. —------------------------------------------------------------------ Question: b) At the last meeting of the Board of Directors of Greenwich Ghana Limited, the Board resolved to establish a manufacturing facility in Asia and Europe. Briefly describe FIVE strategic reasons that might have informed management's decision to undertake the Foreign Direct Investment (FDI). (5 marks) Answer: Strategic Reasons for Foreign Direct Investment (FDI) Access to New Markets By establishing a manufacturing facility in foreign countries, the company gains access to new markets, enabling it to expand its customer base and increase market share. This helps diversify the company’s revenue sources and reduces dependency on the domestic market. (1 mark) Cost Reduction Manufacturing in regions with lower production and labor costs can significantly reduce operational expenses. Asia and Europe might offer cost advantages such as cheaper raw materials, lower wages, or favorable tax policies, making FDI a cost-effective decision. (1 mark) Proximity to Resources Setting up operations closer to key resources (such as raw materials or skilled labor) reduces transportation costs and ensures a more efficient supply chain. This proximity can also lead to better quality control and faster production cycles. (1 mark) Government Incentives Many countries offer incentives such as tax holidays, grants, or subsidies to attract foreign investments. These incentives can lower the company’s overall costs and improve profitability, making FDI an attractive option. (1 mark) Strategic Positioning Against Competitors Establishing a presence in key international markets can be a defensive move to counter competitors who are already operating in those regions. By entering these markets, the company can strengthen its competitive position and ensure it does not lose out on potential opportunities. (1 mark) ========== Let me know if you'd like to proceed with the next part or have any further modifications! Describe five strategic reasons that might motivate a company to undertake foreign direct investment. —------------------------------------------------------------------ Question: b) At the last meeting of the Board of Directors of Greenwich Ghana Limited, the Board resolved to establish a manufacturing facility in Asia and Europe. Briefly describe FIVE strategic reasons that might have informed management's decision to undertake the Foreign Direct Investment (FDI). (5 marks) Answer: Strategic Reasons for Foreign Direct Investment (FDI) Access to New Markets By establishing a manufacturing facility in foreign countries, the company gains access to new markets, enabling it to expand its customer base and increase market share. This helps diversify the company’s revenue sources and reduces dependency on the domestic market. (1 mark) Cost Reduction Manufacturing in regions with lower production and labor costs can significantly reduce operational expenses. Asia and Europe might offer cost advantages such as cheaper raw materials, lower wages, or favorable tax policies, making FDI a cost-effective decision. (1 mark) Proximity to Resources Setting up operations closer to key resources (such as raw materials or skilled labor) reduces transportation costs and ensures a more efficient supply chain. This proximity can also lead to better quality control and faster production cycles. (1 mark) Government Incentives Many countries offer incentives such as tax holidays, grants, or subsidies to attract foreign investments. These incentives can lower the company’s overall costs and improve profitability, making FDI an attractive option. (1 mark) Strategic Positioning Against Competitors Establishing a presence in key international markets can be a defensive move to counter competitors who are already operating in those regions. By entering these markets, the company can strengthen its competitive position and ensure it does not lose out on potential opportunities. (1 mark) ========== Let me know if you'd like to proceed with the next part or have any further modifications! Describe five strategic reasons that might motivate a company to undertake foreign direct investment.

b) At the last meeting of the Board of Directors of Greenwich Ghana Limited, the Board resolved to establish a manufacturing facility in Asia and Europe. Briefly describe FIVE strategic reasons that might have informed management’s decision to undertake the Foreign Direct Investment (FDI). (5 marks)

Strategic Reasons for Foreign Direct Investment (FDI)

  1. Access to New Markets
    • By establishing a manufacturing facility in foreign countries, the company gains access to new markets, enabling it to expand its customer base and increase market share. This helps diversify the company’s revenue sources and reduces dependency on the domestic market.
      (1 mark)
  2. Cost Reduction
    • Manufacturing in regions with lower production and labor costs can significantly reduce operational expenses. Asia and Europe might offer cost advantages such as cheaper raw materials, lower wages, or favorable tax policies, making FDI a cost-effective decision.
      (1 mark)
  3. Proximity to Resources
    • Setting up operations closer to key resources (such as raw materials or skilled labor) reduces transportation costs and ensures a more efficient supply chain. This proximity can also lead to better quality control and faster production cycles.
      (1 mark)
  4. Government Incentives
    • Many countries offer incentives such as tax holidays, grants, or subsidies to attract foreign investments. These incentives can lower the company’s overall costs and improve profitability, making FDI an attractive option.
      (1 mark)
  5. Strategic Positioning Against Competitors
    • Establishing a presence in key international markets can be a defensive move to counter competitors who are already operating in those regions. By entering these markets, the company can strengthen its competitive position and ensure it does not lose out on potential opportunities.
      (1 mark)
  • 3 Marks

AFM – May 2016 – L3 – Q4a – Hedging against financial risk: Non-derivative techniques, Economic environment for multinational

Outline three risk mitigation strategies that a company can adopt to reduce risks affecting profitability.

a) Booms and Bumps Limited has recently been registered as a multinational company dealing in the production and drilling of crude oil in the Oil and Gas industry. Due to uncertainties surrounding the future prospects of the industry, management has hired you as a financial consultant to conduct a risk assessment about the viability of the firm. In the course of the assessment, you constructed a risk register containing various risks that have the potential to affect negatively the profitability of the company.

Required:
Outline THREE basic strategies the management of the company can adopt to mitigate the impact of the risks. (3 marks)

Risk Mitigation Strategies for an Oil and Gas Company

  1. Hedging
    • The company can hedge its exposure to risks such as fluctuating oil prices or currency exchange rates by entering into financial contracts that fix or stabilize future prices. Hedging against price volatility ensures more predictable revenues and reduces the impact of unfavorable market movements.
      (1 mark)
  2. Diversification
    • The company can diversify its operations by investing in different geographic regions or related industries. By spreading investments across various markets and products, the company reduces its dependency on a single market or resource, thus lowering overall risk.
      (1 mark)
  3. Risk Mitigation through Control
    • Implementing strong internal controls and policies to avoid exposure to high-risk projects or ventures that have a lower rate of return. By conducting thorough risk assessments before investing, the company ensures that only projects that meet certain risk-reward criteria are pursued.
      (1 mark)
  • 2 Marks

AFM – May 2018 – L3 – Q1a – Economic environment for multinational organisations

Explaining strategic reasons for engaging in foreign direct investment (FDI).

There are many strategic reasons for Multinational Enterprises to undertake foreign direct investment (FDI) to stimulate economic activity in the host country.

Required:
Explain TWO strategic reasons for engaging in FDI. (2 marks)

Eiteman, Stonehill, and Moffet (1992) in their book, Multinational Business Finance, set out five main strategic reasons for engaging in FDI, as follows:

  • Market Seeking: Firms may be purely exporting to markets overseas or producing in foreign markets to meet local demand. Examples include overseas car manufacturers in Ghana and communication firms in Ghana.
  • Raw Material Seeking: Firms in industries like oil, mining, plantation, and forestry extract raw materials where they are found, whether for export or further processing and sale in the host country.
  • Production Efficiency seeking
    Here firms locate production where one or more factors of production are cheap
    relative to their productivity. A common place example is the utilization of low cost
    labour in the Far East (Taiwan, Malaysia and Mexico)

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