Relationships of Trade and
Foreign Direct Investment Among
China, Taiwan and the U.S.
Hung-Gay Fung, Ph.D
University of Missouri-St. Louis
U.S.A.
Agenda
• General Issues about Trade and Foreign
Direct Investment
• Modes of International Business
• Foreign Direct Investment Analysis
• Trade and Foreign Direct Investment among
China, Taiwan and U.S.
Modes of International Business
• International Trade
– Exports and imports of goods
• Licensing:
– obligates a firm to provide its technology (copyrights,
patents, trademarks or trade names) in exchange for
fees for other benefits
• Franchising:
– franchising obligates a firm to provide a specialized
sales or service strategy, support assistance, and
possibly an initial investment in exchange for periodic
fees.
International Business (continued)
• Joint Ventures
– a venture jointed owned by several firms
– GM’s joint ventures in different countries (China,
Hungary and former Soviet states)
• M &A
– allow firms to take control quickly in foreign markets
– expensive and riskier (may not know local market well)
• Set up Rep Office, new subsidiary, branch
– requires large investment
– takes longer time for operation
Product Life Cycle
Licensing
Exporting
Sales
subsidiary
Service
Facilities
Distribution
system
Production
Overseas
Opportunities
• Increased Globalization enables Firms to:
–
–
–
–
–
–
–
expand their customer base (i.e., product cycle)
exploit lower costs of inputs abroad
arbitrage tax differences across markets
benefit from government subsidies (location)
raise capital at lower cost
diversify production
seek new technology
Risk and Constraints
• Increased Globalization Forces Firms to:
– deal with currency turmoil
– comply with local regulations
•
•
•
•
•
antitrust
labor laws
environmental concerns
capital controls
disclosure
– deal with political uncertainty
International Capital Flows
• Foreign Direct Investment (FDI)
– investment in foreign companies for
management and control
• Portfolio Investment
– investment in foreign companies for capital
gain (not concern for management)
– great implications for crisis
Goals of MNC
• Maximize value of the organization
– NPV of future cash flows
• deal with conflicts of interest
– incentives issue
– agency problems
• Manage different social and structural
impediments such as regulations in
countries
• Another reason for FDI
• diversification
Risk
Pure domestic investment
International
Investment
Number of projects
• Better Risk/return Tradeoff
Return
International
Investment
Pure domestic investment
Risk
Capital Budgeting
• In principle,
– capital budgeting: the same for international and
domestic
– accept positive NPV projects
• In practice, international capital budgeting is more
challenging.
– future cash flows
– discount rate
– taxation
• Strategic considerations are often as important as financial
considerations for evaluating FDI projects.
Cash Flows Analysis
I..O.
0
CF(1)
1
CF(2)
2
CF(2)
n
NPV Rule
T
NPV = 
CFt
- Initial Investment
t (1+k)t
Where:
CFt is the cash flows from the project at time t
k is the discount rate or cost of capital
(from CAPM or other method)
Summary of Factors in Capital Budgeting
Investment
Incremental.
Expectations/
Certainty Eq.
NPV
Growth rate
Discount rate
Terminal
Value
Discount
rate
Specific
Financing
Parent funds
Ret. earnings
Local debt
Equity issue
Incremental Cash Flows
• Cannibalization
– new product taking sales away from the firm’s
existing products
– those sales that would have been lost anyway
should NOT be counted for cannibalization
• Sales Creation
– Have foreign production facilities (Black $
Decker)
• Sunk cost
– not included
• Transfer Pricing
– market price for the goods shipped
• Fees and Royalties
– project should be charged only for additional
expenditures (R & D, management cost, etc)
attributed to the project
• Cash flows from subsidiary vs parent
• Risk analysis
Subsidiary vs Parent
Cash flows generated subsidiary
Tax to host government
After-tax cash flows to subsidiary
Cash flows available to be remitted
to parent
Earnings retained to
subsidiary
Withholding taxes to host
Cash flows to Parent and
tax consideration
Cash flows Diagram
Sales (Price x Quantity sold)
Less COG (variable cost, lease expense, fixed annual,
expense, loyalty, management fees,
depreciation)
=
Earning before tax
Less tax (host government tax)
=
Earnings to subsidiary
Less withholding tax (host country)
=
Earnings to Parent (converted in
parent currency)
Cash Flows (local currency) to Subsidiary:
1. Earnings after tax to subsidiary
2. Depreciation of projects
NPV of cash flows >0 means acceptance
After-Tax Cash flows ($) to Parent
1.
2.
3.
4.
Dividends
Royalty
Management fees
Tax credits paid to host countries
NPV of cash flows
FDI Overall Summary
• FDI is part of overall globalization of markets.
• Strategic considerations for undertaking foreign
projects.
• Capital budgeting for FDI requires
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–
–
–
forecasting the impact of future market conditions,
exchange rate estimates
taxes on the profitability of a project
discount rate has to appropriately account for risk.