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Chapter 5: Q1DQ. (page 679)

What risks does a foreign affiliate of a multinational firm face in today's business world?

Short Answer

Expert verified

Business risks, foreign exchange risk, and political risk

Step by step solution

01

Explanation of Multinational Firm

A multinational corporation generally invests 30% of the firm's business activities in other countries or outside national borders.

02

Risks of foreign affiliate

Firstly, Foreign affiliates of multinational corporations will have business risks: realted sales, market share, competition, etc.

Foreign exchange risk refers to the risk involved due to the exchange rate of currency, as it may go up or down compared to the home country's currency price.

Political risk refers to risks that arises due to political conditions in a foreign country. These adverse political conditions related to will affect negatively to multinational corporation.

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Most popular questions from this chapter

Explain how exports and imports tend to influence the value of a currency

What procedures would you recommend for a multinational company in studying exposure to political risk? What actual strategies can be used to guard against such risk?

Al Simpson helped start Excel Systems several years ago. At the time, he purchased116,000 shares of stock at \(1 per share. Now he has the opportunity to sell his interest in the company to Folsom Corp. for \)50 a share in cash. His capital gains tax rate would be 15 percent.

a. If he sells his interest, what will be the value for before-tax profit, taxes, and aftertax profit?

b. Assume, instead of cash, he accepts Folsom Corp. stock valued at \(50 per share. He pays no tax at that time. He holds the stock for five years and then sells it for \)82.50 (the stock pays no cash dividends). What will be the value for before-tax profit, taxes, and aftertax profit five years from now? His capital gains tax is once again 15 percent.

c. Using a 9 percent discount rate, calculate the aftertax profit. That is, discount back the answer in part b for five years and compare it to the answer in part a.

Comment on any dilemmas that multinational firms and their affiliates may face regarding debt ratio limits and dividend payouts.

The Office Automation Corporation is considering a foreign investment. The initial cash outlay will be \(10 million. The current foreign exchange rate is 2 ugans 5 \)1. Thus the investment in foreign currency will be 20 million ugans. The assets have a useful life of five years and no expected salvage value. The firm uses a straight-line method of depreciation. Sales are expected to be 20 million ugans and operating cash expenses 10 million ugans every year for five years. The foreign income tax rate is 25 percent. The foreign subsidiary will repatriate all aftertax profits to Office Automation in the form of dividends. Furthermore, the depreciation cash flows (equal to each year’s depreciation) will be repatriated during the same year they accrue to the foreign subsidiary. The applicable cost of capital that reflects the riskiness of the cash flows is 16 percent. The U.S. tax rate is 40 percent of foreign earnings before taxes.

  1. Should the Office Automation Corporation undertake the investment if the foreign exchange rate is expected to remain constant during the five year period?
  2. Should Office Automation undertake the investment if the foreign exchange rate is expected to be as follows?

Year 0 .......................... \(152.0ugans

Year 1 .......................... \)152.2ugans

Year 2 .......................... \(152.4ugans

Year 3 .......................... \)152.7ugans

Year 4 .......................... \(152.9ugans

Year 5 .......................... \)1 5 3.2 ugans
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