Presentation on International Finance
Presented To:
Prof. Dr. Mostafa Kamal
Professor, CUET
Professor, FBA, USTC
Presented By:
Name: Nazim Nazmul
ID: 573
Batch: 23rd (Executive for Engineers)
Semester: 3rd (Final)
Session: January 2019
Major: Finance
Date of Presentation: 22nd January, 2021
Faculty of Business Administration (FBA)
University of Science and Technology (USTC)
Topics
Description
1. Balance of Payment
Page
3~9
2. Multinational Capital Budgeting
10~20
3. Foreign Direct Investment
21~28
4. Performance Measurement
29~40
5. International Transfer Pricing
41~49
1. Balance of Payment
Balance Of Payment : Definition
The balance of payments is a systematic record of all economic transactions between
the residents of a country with other country for a specific period of time.
 It presents a classified record of all receipts on account of goods exported, services
rendered and capital received by residents and payments made by them on
account of goods imported and services received from the capital transferred to
non-residents or foreigners.
 It is a double entry system of record of all economic transactions
between the
residents of the country and the rest of the world carried out in a specific period of
time
When we say “a country’s balance of payments” we are referring to the transactions of
its citizens and government.
The Balance of Payments Accounts
A. Current Account
B. Capital Account
C. Statistical Discrepancy (Errors & Omissions)
D. Official Reserves Account
A. Current Account
 BOP on current account is a statement of actual receipts and payments in short
period.
 It includes the value of export and imports of both visible and invisible goods. There
can be either surplus or deficit in current account.
 The current account includes:• export & import of services,
• interests, profits, dividends and unilateral receipts/payments from/to
abroad.
 BOP on current account refers to the inclusion of three balances of namely –
•
Trade balance:
•
Services balance:
•
Unilateral Transfer balance:
B. Capital Account
 The Capital Account of the balance of payments measures all international economic
transactions of financial assets. It is divided into two major components:
•
The Capital Account
•
The Financial Account
 The Capital Account is minor (in magnitude), while the Financial Account is significant
 Financial assets can be classified in a number of different ways including the length of the life
of the asset (maturity) and the nature of the ownership (public or private)
 The Financial Account, however, uses a third method. This focuses on the degree of investor
control over the assets or operations
 The Financial Account consists of three components;
•
Direct Investment – in which the investor exerts some explicit degree of control over the
assets
•
Portfolio Investment – in which the investor has no control over the assets
•
Other Investment – consists of various short-term and long-term trade credits, cross-border
loans, currency deposits, bank deposits and other A/R and A/P related to cross-border
trade
C. Statistical Discrepancy (Errors & Omission)
•
The entries under this head relate mainly to leads and lags in reporting of transactions
•
It is of a balancing entry and is needed to offset the overstated or understated components.
D. The Official Reserve Account
•
Three accounts: IMF, SDR, & Reserve and Monetary Gold are collectively called as The Reserve Account.
•
The IMF account contains purchases (credits) and re-purchase (debits) from International Monetary Fund.
•
Special Drawing Rights (SDRs) are a reserve asset created by IMF and allocated from time to time to
member countries. It can be used to settle international payments between monetary authorities of two
different countries.
The BOP Identity
•
BCA + BKA + BRA = 0
Where,
BCA = Balance on Current Account
BKA = Balance on Capital Account
BRA = Balance on the Reserves Account
Under a pure flexible exchange rete regime,
BCA + BKA = 0
A summary of the US Balance of Payments for 2006 (in $ billion)
Credits
Debits
Current Account
(1) Exports
1167.61
(2) Imports
-1295.53
(3) Unilateral transfer
6.13
Balance on Current Account
-45.01
-166.80
[(1) + (2) + (3)]
Capital Account
(4) Direct investment
(5) Portfolio investment
107.93
387.62
-119.44
-79.28
(6) Other investment
194.95
-227.2
Balance on Financial / Capital Account
[(4) + (5) + (6)]
264.58
(7) Statistical discrepancies
-96.76
Overall balance
1.02
Official Reserve Account
Source: IMF, International Financial Statistics
-1.02
Yearbook, 2008.
23
Warren Buffet
02/01/2016
2. Capital Budgeting
An Investment Decision Method
Definition of Budget
•Budgeting is a management tool for controlling and planning future activity.
Financial Buzz Words: A plan for saving, borrowing and spending.
Budget is a financial plan and a list of all planned expenses and revenues
Capital Budgeting
Capital: Operating assets used for production.
Budget: A plan that details projected cash flows during some period.
Capital Budgeting: Process of analyzing projects and deciding which
ones to include in capital budget.
Importance of Capital Budgeting
Growth
Large Amount
Irreversibility
Complexity
Risk
Long term implications
Benefits of Capital Budgeting Decision:
Capital Budgeting decisions evaluate a proposed project to forecast
return from the project and determine whether return from the Project is
adequate.
Capital Budgeting decisions evaluate expenditure decisions which
involve current outflow of funds but are likely to produce benefits over a
period of time more than one year.
Capital Budgeting: Project Categorization
•
Establishment of New Products & Services
•
Replacement Projects: Maintenance or Cost Reduction
•
Expansion of Existing Projects
•
Research and Development Projects
•
Long Term Cotracts
•
Safety and/or Environmental Projects
Evaluation Criteria: Capital Investment Proposal
Evaluation Criteria
Discounting
criteria
Non-Discounting
Criteria
Pay-Back
Period
ARR
Discounted
PBP
NPV
Profitability
Index
IRR
Non discounting: Pay-Back Period
1. Pay-Back Period Method- It is defined as the number of years required to recover original cost
invested in a project. It has two conditions

When cash inflow is constant every year
PBP= Cash outflow/cash inflow (p.a.)

When cash inflow are not constant every year
Required inflow
*
In flow of next year
PBP =Completed years +
12
Non discounting Criteria: Annual Rate ofReturn
2.Average Rate of Return Method - ARR means the average annual earning on the project.
Under this method, profit after tax and depreciation is considered. The average rate of return can
be calculated in the following two ways.
ARR on Average investment
ARR on Initial investment
=
=
Average Profit After Tax
*100
Average Investment
Average Profit After Tax
Initial Investment
*100
Discounting Criteria: Pay-Back Period
3. Discounted Pay-Back Period Method - In discounted pay- back period method, the cash inflows are
discounted by applying the present value factors for different time periods. For this, discounted cash inflows
are calculated by multiplying the P.V.factors into cashinflows.
Required inflow
12
*
Dis. PBP = Completed years +
In flow of next year
Discounting Criteria: Net Present Value
4.
Net Present Value Method:- It is the best method for evaluation of investment proposal. This method
takes account time value of money.
NPV= PV of inflows- PV of outflows
 Evaluation of Net Present Value Method:- Project with the higher NPV should be selected.
Accept
if
NPV>0
Reject
NPV<0
May or may not accept
NPV=0
Discounting Criteria: Profitability Index
5. Profitability Index Method - As the NPV method it is also shows that project is accepted or not. If
.
Profitability index is higher than 1, the proposal can be accepted
Accepted
Rejected
PI>1
PI<1
Profitability index =
Total Cash Inflows
Total Cash Outflows
Discounting Criteria: Internal Rate of Return
6. Internal Rate of Return Method:- IRR is the rate of return that a project earns. The rate of discount
calculated by trial and error , where the present value of future cash flows is equal to the present value of
outflows, is known as the Internal Rate of Return.
NPV of Higher Rate
Difference in Rate
IRR = Higher Rate Difference in cash flows
*
IRR = Lower Rate +
NPV of Lower Rate
Difference in cash flows
*
Difference in Rate
Example
The expected cash flows of a project are:Year
1
2
3
4
5
Cash Flows ( Rs.)
20,000
30,000
40,000
50,000
30,000
The cash outflow is Rs. 1,00,000 The cost of capital is 10% Calculate the following:
a) NPV
b) Profitability Index
c) IRR
d) Pay-back period
e) Discounted Pay-back Period
Computation of NPV and PI
Year
1
2
3
4
5
Cash Flows (Rs.)
20,000
30,000
40,000
50,000
30,000
Total Cash Inflow
Least: Cash
Outflow
NPV
P.I.
PV Factors@10%
.909
.826
.751
.683
.620
PV of Cash Flows (Rs.)
18,180
24,780
30,040
34,150
18,600
1,25,750
1,00,000
Computation of NPV & PI
25,750
1.2575
Computation of IRR
Year
1
2
3
4
5
Cash Flows (Rs.)
PV Factors @19%
20,000
30,000
40,000
50,000
30,000
Total Cash Inflow
Less
Cash Outflows
NPV
.84
.706
.593
.499
.42
PV of Cash Flows
(Rs.)
16,800
21,180
23,720
24,950
12,600
99,250
1,00,000
(-)750
PV Factors @18%
.847
.718
.609
.516
.437
PV of Cash Flows
(Rs.)
16,940
21,540
24,360
25,800
13,110
1,01,750
1,00,000
(+)1750
Computation of non discounting pay-back period
Year
1
2
3
4
5
Cash Flows (Rs.)
20,000
30,000
40,000
50,000
30,000
Cumulative Cash Flow
20,000
50,000
90,000
1,40,000
1,70,000
PBP = Completed years +Required inflow*12
Inflow of Next year
=
3years+ (1,00,000-90,000) *12
50,000
= 5.4 years
Computation of discounted pay-back period
Year
1
2
3
4
5
Cash Flows
(Rs.)
20,000
30,000
40,000
50,000
30,000
PV Factors@10%
PBP= Completed years + Required inflow *12
Inflow of Next year
=
3years+ (1,00,000-73,000)*12
34150
=
12.48 years
.909
.826
.751
.683
.620
PV of Cash
Flows (Rs.)
18,180
24,780
30,040
34,150
18,600
Cumulative
Cash Flows
18,180
42,960
73,000
1,07,150
1,25,750
Conclusions
We have Studied various evaluation criteria for Capital
Budgeting.
Generally an impression created that the firm should
use NPV method for decision making.
Most of the large companies consider all the measures
because each one provides somewhat different piece of
relevant information to the decision maker.
THANK YOU!
3. FOREIGN DIRECT INVESTMENT
WHAT IS FDI?



Foreign direct investment is an investment in a
business by an investor from anther country for
which the foreign investor has control over the
company purchased.
It is also defined as cross border investment made
by a resident in one economy in an enterprise in
another company.
FDI is direct investment into production in a country
by a company located in another country ,either by
buying a company in the target country or by
expanding operations of an existing business in that
country.
TYPES OF FDI

BY
DIRECTION
BY MOTIVE
BY TARGET
BY ENTRY
MODES
BY TARGET
HORIZONTAL FDI :
Where the company carries out the same activities abroad as at home (for example toyota assembling cars in
both japan and U.K)
Often in an attempt to achieve economies of scale and/or scope.
VERTICAL FDI:

When different storage of activities are added abroad .

Often in an attempt to control supply or distribution channels

Where the FDI takes the firm nearer to the market
is called Forward vertical FDI.(for example toyota
acquiring a car distributorship in america)

Where international integration moves back towards raw materials is called Backward vertical FDI.(for
example toyota acquiring a tyre manufacturers)
BY MOTIVE

Resource seeking:-looking for resources at a lower real cost.

Market seeking:-secure market share and sales growth in target foregion market.

Efficiency seeking:-seeks to establish efficient structure through useful factors ,cultures,
policies or markets.

Strategic asset seeking:-seeks to acquire assets in foreign farms that promote corporate
long term objectives.
BY DIRECTION
INWARD FDI:
An inward investment involves an foreign entity either investing in or purchasing the goods of a local company.

EXAMPLE: General Motors decides to open a factory in Malaysia. They are going to invest some capital.
That capital is inward FDI for Malaysia
OUTWARD FDI:
An outward investment is a business strategy where a domestic firm expands its operations to a foreign country
either via acquisition or expansion of an existing foreign facility.

Outward FDI faces restrictions under a host of factors as described below:

Industries related to defense are often set outside the purview of outward FDI to retain government's control
over the defense related industrial complex.

Subsidy scheme targeted at local businesses.

Government policies, which lend support to the phenomenon of industry nationalization
BY ENTRY MODES
GREENFIELD INVESTMENT:
Greenfield investment is the investment in a manufacturing ,office,etc.

It is the idea of building a facility on a green field such as farmland or a forest.
MERGERS AND ACQUISITIONS:
A merger is a combination of two companies to form a new company, while an acquisition is the purchase of
.
one company by another company in which a new company is formed
BENEFITS OF FDI

Improve foreign exchange position of the country.

Employment generation and increase in production.

Help in capital formation by bringing fresh capital.

Helps in transfer of new technologies and management skill.

Helps in increase exports.

Increases tax revenues.
DISADVANTAGES OF FDI

Domestic companies fear that they may lose their ownership.

Small companies fear that they may not be able to compete
with world class large companies.

Foreign companies invest more in machinery and intellectual property than in wages of the
local people.

Government has less control over the functioning of such companies as they usually work as
wholly owned subsidiary of an overseas company.
Political Risk and FDI
• Unquestionably this is the biggest risk when investing abroad.
• “Does the foreign government uphold the rule of law?” is a more important question than normative judgements about the
appropriateness of the foreign government’s existing legislation.
• A big source of risk is the non-enforcement of contracts
Depending on the incidence, 02 types of Risk
• Macro Risk
All foreign operations put at risk due to adverse political developments.
• Micro Risk
Selected foreign operations put at risk due to adverse political developments
Depending on the manner in which firms are affected, 03 types of Risk
• Transfer Risk
Uncertainty regarding cross-border flows of capital.
• Operational Risk
Uncertainty regarding host countries policies on firm’s operations.
• Control Risk
Uncertainty regarding expropriation
THANK YOU
4. Performance Measurement
PPT 10-29
Measuring the Performance of
Investment Centers
 Return on Investment (ROI)
 Residual Income (RI)
 Economic Value Added (EVA)
PPT 10-30
Return on Investment (ROI)
An investment center’s performance is often evaluated using a measure called
return on investment (ROI). ROI is defined as
net operating income divided by average operating assets.
Net operating income is income before taxes and is sometimes referred to as
earnings before interest and taxes (EBIT). Operating assets include cash, accounts
receivable, inventory, plant and equipment, and all other assets held for operating
purposes.
Net operating income is used in the numerator because the denominator consists
only of operating assets.
The operating asset base used in the formula is typically computed as the average
operating assets (beginning assets + ending assets) divided by 2.
PPT 10-31
Return on Investment (ROI) Formula
Income before interest
and taxes (EBIT)
ROI =
Net operating income
Average operating assets
Cash, accounts receivable, inventory,
plant and equipment, and other productive assets
ROI =
.
Net operating income
Average operating assets
Net operating income
Margin =
Sales
Turnover =
Sales
Average operating assets
PPT 10-32
ROI = Margin  Turnover
An ROI Example
Year 1:
Sales
Operating income
Average operating assets
Snack Foods
Division
$30,000,000
1,800,000
10,000,000
Appliance
Division
$117,000,000
3,510,000
19,500,000
Year 2:
Sales
Operating income
Average operating assets
$40,000,000
2,000,000
10,000,000
$117,000,000
2,925,000
19,500,000
Minimum return of 10%
Snack Food
Appliance
Year 1
Year 2
Year 1
Year 2
Margin
6.0%
5.0%
3.0%
2.5%
Turnover
x 3.0
x 4.0
x 6.0
x 6.0
20.0%
===
18.0%
===
15.0%
===
===
ROI
18.0%
PPT 10-33
10-34
Increasing ROI
There are three ways to increase ROI . . .
Reduce
Increase Expenses Reduce
Sales
Assets
PPT 10-34
Advantages of ROI

It encourages managers to pay careful attention to the relationships among sales,
expenses, and investment, as should be the case for a manager of an investment center.

It encourages cost efficiency.

It discourages excessive investment in operating assets.
Disadvantages of ROI

It discourages managers from investing in projects that would decrease the divisional
ROI but would increase the profitability of the company as a whole. (Generally,
projects with an ROI less than a division’s current ROI would be rejected.)

It can encourage myopic behavior, in that managers may focus on the short run at the
expense of the long run
.
PPT 10-35
10-36
Residual Income - Another Measure of Performance
Net operating income
above some minimum
required return on
operating assets
Residual income is the difference between operating income and the minimum dollar return
required on a company’s operating assets:
 Residual income = Operating income - (Minimum rate of return x Operating assets)
PPT 10-36
10-37
Calculating Residual Income
Residual
=
income
Net
operating income
Average
operating
assets

Minimum
required rate of
return
ROI measures net operating income earned relative to the investment in average operating assets
.
Residual income measures net operating income earned less the minimum required return on
average operating assets
.
Residual Income Example
Investment
Operating income
Targeted ROI
Project I
Project II
$10,000,000
$4,000,000
1,300,000
640,000
10%
10%
Project I
Residual income = Operating income - (Minimum rate of return x Operating assets)
Residual income
= $1,300,000 - (0.10 x $10,000,000)
= $1,300,000 - $1,000,000
= $300,000
Project II
Residual income
= $640,000 - (0.10 x $4,000,000)
= $640,000 - $400,000
= $240,000
PPT 10-37
Residual Income Example
Project I
Residual income = Operating income - (Minimum rate of return x Operating assets)
Residual income
= $1,300,000 - (0.10 x $10,000,000)
= $1,300,000 - $1,000,000
= $300,000
Project II
Residual income
= $640,000 - (0.10 x $4,000,000)
= $640,000 - $400,000
= $240,000
PPT 10-38
Economic Value Added
Economic value added (EVA) is after-tax operating profit minus the total annual cost of capital.
The equation for EVA is expressed as follows:
EVA = After-tax operating income - (Weighted average cost of capital) x (Total capital employed)*+9
EVA Example
Suppose that Furman, Inc., had after-tax operating income last year of $1,583,000. Three sources of financing were used by the
company: $2 million of mortgage bonds paying 8 percent interest, $3 million of unsecured bonds paying 10 percent interest, and $10
million in common stock, which was considered to be no more or less risky than other stocks. Furman, Inc., pays a marginal tax rate
of 40 percent.
The weighted average cost of capital for Furman, Inc. is computed as follows:
Common stock
Mortgage bonds
Unsecured bonds
Total
Amount
Percent
x After-Tax Cost
= Weighted Cost
$10,000,000
0.667
0.120
0.080
0.133
0.048
0.006
0.200
0.060
0.012
2,000,000
3,000,000
$15,000,000
=========
0.098
====
Furman’s EVA is calculated as follows:
After-tax profit
Less: Weighted average cost of capital
EVA
$1,583,000
1,470,000
$ 113,000
=========
10-39
The positive EVA means that Furman, Inc., earned operating profit over and above the cost of thePPT
capital
used.
PPT 10-40
5. TRANSFER PRICING
A Transfer Price is the price at which divisions of a company transfer recourses
with each other.
Transfer pricing is the setting of the price for goods and services sold between
related legal entities with an enterprise.
E.g.: If a Subsidiary Company sells goods to a parent company , the cost of those
goods is the transfer price
Types of Internal Transactions
A transfer pricing arrangement can be
between,
• Between Inter-Company Departments
• Parent Company and Subsidiary
• Between two Subsidiaries of the Parent
Company
OBJECTIVES
1.
2.
3.
4.
Optimum use of inter departmental resources.
In a decentralized unit, they are free to exercise their rights in transfer good and services.
Problem solver for each other entity.
Generates managerial affairs towards inter-divisional healthy competition and application
of each other difficulties.
5. Optimizer for allocational financial resources.
6. Provider of information related to decision making
7. Used as a tool in minimizing taxes, skimming profit and defeating foreign exchange
restrictions.
Methods of Transfer Pricing
1.
Cost Based Transfer Pricing
2.
Market Based Transfer Pricing
3.
Negotiated Transfer Pricing
Cost Based Pricing
Different forms of cost based transfer pricing,
•
•
•
•
Variable cost
Actual full cost
full cost plus profit margin
Standard full cost
Market Based Transfer Pricing
When the outside market for the good is well defined, competitive and stable, firms often use the market price as an
upper bound for the transfer price
Advantages of Market Based Transfer Pricing
a. Managers motivation increases because they have more control over assets
b. Top managers are not distracted by routine
c. Forces selling division to be competitive with market conditions
d. Decisions are better and timelier because of the manager’s proximity to local conditions
Negotiate Transfer Pricing
•
•
Negotiated Transfer Pricing can be defined as the price set by negotiation between the
buying and selling divisions.
The negotiated transfer prices,
- Seller’s perspective:
Transfer price > Variable cost + opportunity cost
- Purchaser’s perspective:
Transfer price < Cost of buying from outside suppliers
Advantage of Negotiate Transfer Pricing
1.
Not need of active market for a particular good.
2.
Full autonomy to buy and sell.
3.
Managers are fully informed.
4.
Time saving method.
5.
Motivational factor
Drawbacks of Negotiate Transfer Pricing
1. The parties does not have equal bargaining power
2. Risk for disharmony with opportunity costs.
3. Conflicts on transfer prices between divisions
Advantages
•
•
•
•
•
•
•
Allows the company to generate profit figures for each division in separate manner.
The sales, pricing and the production departments can be coordinated through this
method
Helps in resource allocation
Performance evaluation of each department becomes easy
Decisions become better and more timely
Managers’ motivation increases
Reducing income taxes
Disadvantages
•
Disagreement among organizational divisional managers
•
Additional costs, time and manpower will be required
•
Transfer prices do not work equally
•
Cause dysfunctional behavior
•
Highly complicated
•
Difficult to estimate the right amount of pricing policy
THANK YOU