Chapter 15
Multinational Restructuring
Lecture Outline
Background on International Acquisitions
Trends in International Acquisitions
Model for Valuing a Foreign Target
Market Assessment of International Acquisitions
Assessing Potential Acquisitions After the Asian Crisis
Assessing Potential Acquisitions in Europe
Factors that Affect the Expected Cash Flows of the Foreign Target
Target-Specific Factors
Country-Specific Factors
Example of the Valuation Process
International Screening Process
Estimating the Target’s Value
Changes in Valuation Over Time
Why Valuations of a Target May Vary Among MNCs
Estimated Cash Flows of the Foreign Target
Exchange Rate Effects on the Funds Remitted
Required Return of Acquirer
Other Types of Multinational Restructuring
International Partial Acquisitions
International Acquisitions of Privatized Businesses
International Alliances
International Divestitures
Restructuring Decisions as Real Options
Call Option on Real Assets
Put Option on Real Assets
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Chapter Theme
This chapter emphasizes that the strategic plan of an MNC can be modified continuously in response
to changing global conditions, and multinational restructuring may be needed to achieve the plan.
Some of the more critical issues related to multinational restructuring are discussed.
Topics to Stimulate Class Discussion
1. Why do MNCs consider multinational restructuring?
2. How should MNCs determine whether multinational restructuring is worthwhile?
3. What are common ways by which an MNC can conduct multinational restructuring?
4. What role does valuation play in the multinational restructuring process?
POINT/COUNTER-POINT:
Can a Foreign Target Be Assessed Like Any Other Asset?
POINT: Yes. The value of a foreign target to an MNC is the present value of the future cash flows to
the MNC. The process of estimating a foreign target’s value is the same as the process of estimating a
machine’s value. A target has expected cash flows, which can be derived from information about
previous cash flows.
COUNTER-POINT: No. A target’s behavior will change after it is acquired by an MNC. Its
efficiency may change depending on the ability of the MNC to integrate the target with its own
operations. The morale of the target employees could either improve or worsen after the acquisition,
depending on the treatment by the acquirer. Thus, a proper estimate of cash flows generated by the
target must consider the changes in the target due to the acquisition.
WHO IS CORRECT? Use the Internet to learn more about this issue. Which argument do you
support? Offer your own opinion on this issue.
ANSWER: Some targets may continue their business in the same manner as before, and their cash
flows may not change significantly. Others are restructured due to the acquisition, so their cash flows
might deviate substantially from before the acquisition.
Answers to End of Chapter Questions
1. Motives for Restructuring. Why do you think MNCs continuously assess possible forms of
multinational restructuring, such as foreign acquisitions or downsizing of a foreign subsidiary?
ANSWER: MNCs continuously assess possible forms of multinational restructuring so that they
can capitalize on changing economic, political, or industry conditions across countries. These
conditions may present opportunities not available in the U.S.
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2. Exposure to Country Regulations. Maude Inc., a U.S.-based MNC, has recently acquired a firm
in Singapore. To eliminate inefficiencies, Maude downsized the target substantially, eliminating
two-thirds of the workforce. Why might this action affect the regulations imposed on the
subsidiary’s business by the Singapore government?
ANSWER: One of the benefits of direct foreign investment from a host government’s viewpoint
is the potential reduction of unemployment. If a U.S.-based MNC such as Maude contributes to
growing unemployment in the host country, the government may impose special taxes or
requirements that would render further expansion in Singapore undesirable.
3. Global Expansion Strategy. Poki Inc., a U.S.-based MNC, is considering expanding into
Thailand because of decreasing profit margins in the U.S. The demand for Poki’s product in
Thailand is very strong. However, forecasts indicate that the baht is expected to depreciate
substantially over the next three years. Should Poki expand into Thailand? What factors may
affect its decision?
ANSWER: Poki faces a tradeoff. Demand for its product in Thailand is very strong, while it is
deteriorating in the U.S. However, the baht is expected to depreciate substantially, which would
reduce the dollar value of any baht remitted back to the parent.
Poki’s decision should be affected by the amount of cash flows that is subject to the baht’s
depreciation. If Poki plans to keep the funds in Thailand until the baht begins to appreciate again,
it is not subject to the depreciation. Also, even if baht-denominated funds are remitted to the U.S.
on a regular basis in periods when the baht is depreciating, the strong demand in Thailand may
generate satisfactory profits; Poki may even be able to increase the price of its product. Poki may
also consider investigating the demand for its product in other foreign countries whose currencies
are not expected to depreciate.
4. Alternatives to International Acquisitions. Rastell Inc., a U.S.-based MNC, is considering the
acquisition of a Russian target to produce personal computers (PCs) and market them throughout
Russia, where demand for PCs has increased substantially in recent years. Assume that the stock
market conditions are not favorable in Russia, as the stock prices of most Russian companies rose
substantially just prior to Rastell’s assessment of the target. What are some alternatives available
to Rastell?
ANSWER: There are at least two alternatives available to Rastell Inc. First, it could enter into a
licensing agreement with the Russian target to manufacture and distribute PCs with the Rastell
name throughout Russia. Second, it could enter into a joint venture with the potential Russian
target. Both of these methods would allow Rastell to access the Russian PC market. Furthermore,
when stock prices in Russia decline, Rastell could make a bid for the potential Russian target.
5. Comparing International Projects. Savannah, Inc., a manufacturer of clothing, wants to
increase its market share by acquiring a target producing a popular clothing line in Europe. This
clothing line is well established. Forecasts indicate a relatively stable euro over the life of the
project. Marquette, Inc., wants to increase its market share in the personal computer market by
acquiring a target in Thailand that currently produces radios and converting the operations to
produce PCs. Forecasts indicate a depreciation of the baht over the life of the project. Funds
resulting from both projects will be remitted to the respective U.S. parent on a regular basis.
Which target do you think will result in a higher net present value? Why?
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ANSWER: The European target will likely result in a higher NPV. First, the euro has generally
been more stable than the Thai baht. The Thai baht is expected to depreciate, which would result
in a reduction in dollar cash flows remitted to Marquette, which would reduce the net present
value associated with that project. Second, Savannah will likely continue the operations of the
acquired European target, while Marquette will substantially change the target’s existing
operations. Consequently, there is much greater uncertainty regarding the Thailand project, which
would result in a higher required rate of return. A higher required rate of return will reduce the
net present value associated with a project.
6. Privatized Business Valuations. Why are valuations of privatized businesses previously owned
by the governments of developing countries more difficult than valuations of existing firms in
developed countries?
ANSWER: There are several reasons why the valuation of a privatized business may be more
difficult than the valuation of an existing firm in a developed country. First, future cash flows
associated with a privatized business are very uncertain because the businesses previously have
been operating in environment of little or no competition. Second, there are very limited data in
some of these countries. Third, economic conditions in these countries are very uncertain. Fourth,
exchange rate estimates are very uncertain. Fifth, the cost of local financing for projects in
developing countries is very uncertain. Sixth, the lack of established stock markets in developing
countries prevents an MNC from deriving a value for a business based on comparable publicly
held firms. Seventh, the government may retain part of the firm, which could lead to control
conflicts in the future.
7. Valuing a Foreign Target. Blore Inc., a U.S.-based MNC, has screened several targets. Based on
economic and political considerations, only one eligible target remains in Malaysia. Blore would
like you to value this target and has provided you with the following information:
•
Blore expects to keep the target for three years, at which time it expects to sell the firm for
300 million Malaysian ringgit (MYR) after any taxes.
•
Blore expects a strong Malaysian economy. The estimates for revenue for the next year are
MYR200 million. Revenues are expected to increase by 8% in each of the following two
years.
•
Cost of goods sold are expected to be 50% of revenue.
•
Selling and administrative expenses are expected to be MYR30 million in each of the next
three years.
•
The Malaysian tax rate on the target’s earnings is expected to be 35 percent.
•
Depreciation expenses are expected to be MYR20 million per year for each of the next three
years.
•
The target will need MYR7 million in cash each year to support existing operations.
•
The target’s stock price is currently MYR30 per share. The target has 9 million shares
outstanding.
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•
Any remaining cash flows will be remitted by the target to Blore Inc. Blore uses the
prevailing exchange rate of the Malaysian ringgit as the expected exchange rate for the next
three years. This exchange rate is currently $.25.
•
Blore’s required rate of return on similar projects is 20 percent.
a. Prepare a worksheet to estimate the value of the Malaysian target based on the information
provided.
ANSWER:
Valuation of Malaysian Target Based on the Assumptions Provided
(numbers are in millions)
Revenue
Cost of Goods Sold
Gross Profit
Selling & Admin. Exp.
Depreciation
Earnings Before Taxes
Tax (35%)
Earnings After Taxes
+ Depreciation
– Funds to Reinvest
Year 1
Year 2
Year 3
MYR200
MYR100
MYR100
MYR216
MYR108
MYR108
MYR233.3
MYR116.6
MYR116.7
MYR30
MYR20
MYR50
MYR30
MYR20
MYR58
MYR30
MYR20
MYR66.7
MYR17.5
MYR32.5
MYR20.3
MYR37.7
MYR23.3
MYR43.4
MYR20
MYR7
MYR20
MYR7
MYR20
MYR7
Sale of Firm
Cash Flows in MYR
Exchange Rate of MYR
Cash Flows in $
PV (20% disc. rate)
Cumulative PV
MYR300
MYR45.5
$.25
$11.4
MYR50.7
$.25
$12.7
MYR356.4
$.25
$89.1
$9.5
$9.5
$8.8
$18.3
$51.6
$69.9
The value of the Malaysian target based on the information provided is $69.9 million.
b. Will Blore Inc. be able to acquire the Malaysian target for a price lower than its valuation of
the target?
ANSWER: The Malaysian target’s shares are presently valued at MYR30 per share. Thus, the 9
million shares outstanding are worth MYR270 million. At the prevailing exchange rate of $.25,
the target is presently valued at $67.5 million (computed as MYR270 million × $.25). The
MNC’s valuation of the target is $69.9 million, which is only about 3.5% above the market
valuation. However, Blore will have to pay a premium on the shares to entice the target’s board
of directors to approve the acquisition. Premiums commonly range from 10 percent to 40 percent
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of the market price. Therefore, it is unlikely that Blore could purchase the target for a price that is
below its valuation of the target.
8. Uncertainty Surrounding a Foreign Target. Refer to question 7. What are some of the key
sources of uncertainty in Blore’s valuation of the target? Identify two reasons why the expected
cash flows from an Asian subsidiary of a U.S.-based MNC would have been lower as a result of
the Asian crisis.
ANSWER: There is much uncertainty regarding the assumptions employed. For example, the
growth rate in revenues may be overestimated if Blore has overestimated the growth rate of the
Malaysian economy. The estimates of expenses may be inaccurate. Also, the exchange rate of the
Malaysian ringgit may be weaker than what was assumed. Blore would prefer to purchase the
target for an amount that is substantially less than its valuation of the target because it provides
Blore with more of a cushion if the target’s value turns out to be less than what was estimated.
9. Divestiture Strategy. The reduction in expected cash flows of Asian subsidiaries as a result of
the Asian crisis likely resulted in a reduced valuation of these subsidiaries from the parent’s
perspective. Explain why a U.S.-based MNC might not have sold its Asian subsidiaries.
ANSWER: The valuation of the subsidiaries would have declined because of the reduction in
cash flows, so potential buyers may not have been willing to pay an amount that even reflects the
present value of the expected future cash flows. Thus, the parent should have retained the
subsidiaries if it could not sell them for an amount at least equal to their respective values.
10. Why a Foreign Acquisition May Backfire. Provide two reasons why an MNC’s strategy of
acquiring a foreign target will backfire. That is, explain why the acquisition might result in a
negative NPV.
ANSWER: The MNC may overestimate the cash flows to be generated by the target, due to
overestimating the revenues or underestimating the cost of operating the target. In addition, it
may overestimate the future salvage value of the target.
Advanced Questions
11. Pricing a Foreign Target. Alaska Inc. would like to acquire Estoya Corp., which is located in
Peru. In initial negotiations, Estoya has asked for a purchase price of 1 billion Peruvian new sol.
If Alaska completes the purchase, it would keep Estoya’s operations for two years and then sell
the company. In the recent past, Estoya has generated annual cash flows of 500 million new sol
per year, but Alaska believes that it can increase these cash flows by 5 percent each year by
improving the operations of the plant. Given these improvements, Alaska believes it will be able
to resell Estoya in two years for 1.2 billion new sol. The current exchange rate of the new sol is
$.29, and exchange rate forecasts for the next two years indicate values of $.29 and $.27,
respectively. Given these facts, should Alaska Inc. pay 1 billion new sol for Estoya Corp. if the
required rate of return is 18 percent? What is the maximum price Alaska should be willing to
pay?
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ANSWER:
Year
Operating CF
Sale of Estoya
Cash flows in new sol
Exchange rate
Cash flows in $
PV (18% discount rate)
Cumulative PV
0
1
525.00
525.00
$.29
$152.25
$129.03
$129.03
2
551.25
1,200.00
1,751.25
$.27
$472.84
$339.59
$468.62
Alaska, Inc. should not pay more than $468.62 million for Estoya Corp. Estoya is asking for 1.2
billion new sol, which translates to $348 million at the current exchange rate of $.29. Therefore,
Alaska, Inc. should purchase Estoya Corp.
12. Global Strategy. Senser Co. established a subsidiary in Russia two years ago. Under its original
plans, Senser intended to operate the subsidiary for a total of four years. However, it would like
to reassess the situation, since exchange rate forecasts for the Russian ruble indicate that it may
depreciate from its current level of $.033 to $.028 next year and to $.025 in the following year.
Senser could sell the subsidiary today for 5 million rubles to a potential acquirer. If Senser
continues to operate the subsidiary, it will generate cash flows of 3 million rubles next year and 4
million rubles in the following year. These cash flows would be remitted back to the parent in the
U.S. The required rate of return of the project is 16 percent. Should Senser continue operating the
Russian subsidiary?
ANSWER:
End of Year 2
Rubles remitted
Selling price
Exchange rate
Cash flow from divestiture
Cash flows forgone
PV of forgone CF (16%)
5,000,000
$.033
$165,000
End of Year 3
3,000,000
End of Year 4
4,000,000
$.028
$.025
$84,000
$72,413.79
$100,000
$74,316.29
NPVd = $165,000 − ($72,413.79 + $74,316.29)
= $18,269.92
Senser Co. should consider divesting its subsidiary, since the present value of the cash flows is
less than the price it could sell the subsidiary for today.
13. Divestiture Decision. Colorado Springs Co. plans to divest either its Singapore or its Canadian
subsidiary. Assume that if exchange rates remain constant, the dollar cash flows each of these
subsidiaries would provide to the parent over time would be somewhat similar. However, the firm
expects the Singapore dollar to depreciate against the U.S. dollar, and the Canadian dollar to
appreciate against the U.S. dollar. The firm can sell either subsidiary for about the same price
today. Which one should it sell?
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International Financial Management
ANSWER: It should sell the Singapore subsidiary because the forgone cash flows to the parent
will be less. If the Singapore dollar depreciates, the dollar cash flows received by the parent will
decline.
14. Divestiture Decision. San Gabriel Corp. recently considered divesting its Italian subsidiary and
determined that the divestiture was not feasible. The required rate of return on this subsidiary was
17 percent. In the last week, San Gabriel’s required return on that subsidiary increased to 21
percent. If the sales price of the subsidiary has not changed, explain why the divestiture may now
be feasible.
ANSWER: As a project’s required rate of return increases, the present value of cash flows
decreases. Also, the present value of foreign cash flows would decrease and may now be lower
than the proceeds received from the divestitures.
15. Divestiture Decision. Ethridge Co. of Atlanta, Georgia has a subsidiary in India that produces
products and sells them throughout Asia. In response to the September 11, 2001 terrorist attack
on the U.S., Ethridge Co. decided to conduct a capital budgeting analysis to determine whether it
should divest the subsidiary. Why might this decision be different after the attack as opposed to
before the attack? Describe the general method for determining whether the divestiture is
financially feasible.
ANSWER: The divestiture decision may be different because cash flow estimates may have
changed since the attack. Estimated revenue generated by its U.S. subsidiary may decline because
of friction between the U.S. and some consumers in central Asia. In addition, the expenses
associated with security and insurance would likely increase. However, the potential salvage
value may have declined as a result of the attack also.
The divestiture decision involves a comparison of the dollars that would be received from selling
the subsidiary versus the present value of dollar costs associated with keeping the subsidiary.
16. Feasibility of a Divestiture. Merton Inc. has a subsidiary in Bulgaria that it fully finances with
its own equity. Last week, a firm offered to buy the subsidiary from Merton Inc. for $60 million
in cash and the offer is still available this week as well. The annualized long-term risk-free rate in
the U.S. increased from 7% to 8% this week. The expected monthly cash flows to be generated by
the subsidiary have not changed since last week. The risk premium that Merton Inc. applies to its
projects in Bulgaria was reduced from 11.3% to 10.9% this week. The annualized long-term riskfree rate in Bulgaria declined from 23% to 21% this week. Would the NPV to Merton Inc. from
divesting this unit be more or less than the NPV determined last week? Why? (No analysis is
necessary, but make sure that your explanation is very clear.)
ANSWER: The NPV of the divestiture would be higher because a higher discount rate would be
used as the required rate of return applied to the subsidiary’s cash flows. The risk-free rate
increased by 1% while the risk premium is reduced by .4%, so the required rate of return has
increased by .6%. The present value of the forgone cash flows should be lower this week, which
means that the NPV from divesting the unit should be higher.
17. Accounting for Government Restrictions. Sunbelt Inc. plans to purchase a firm in Indonesia. It
believes that it can install its operating procedure in this firm, which would significantly reduce
the firm’s operating expenses. However, the Indonesian government may approve the acquisition
only if Sunbelt does not lay off any workers. How can Sunbelt possibly increase efficiency
Chapter 15: Multinational Restructuring
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without laying off workers? How can Sunbelt account for the Indonesian government’s position
as it assesses the NPV of this possible acquisition?
ANSWER: Sunbelt should first consider the profile of the workers who it would lay off if it could
after improving the operations. Then, it could decide how it could revise the job descriptions so
that those workers who are no longer needed for normal operations can be utilized in a different
manner. Then, Sunbelt should estimate the NPV of this potential acquisition after considering
these conditions. It may not be able to reduce labor expenses in the way that it desired if layoffs
are prohibited, but it may achieve increased production, which could lead to higher revenue, and
therefore the acquisition may be feasible.
18. Foreign Acquisition Decision. Florida Co. produces software. Its primary business in Boca
Raton is expected to generate cash flows of $4,000,000 at the end of each of the next 3 years, and
expects that it could sell this business for $10 million (after accounting for capital gains taxes) at
the end of 3 years. Florida Co. also has a side business in Pompano Beach that takes the software
created in Boca Raton and exports it to Europe. As long as the side business distributes this
software to Europe, it is expected to generate $2 million in cash flows at the end of each of the
next three years. This side business in Pompano Beach is separate from Florida’s main business.
Recently, Florida was contacted by a Ryne Co. in Europe which specializes in distributing
software throughout Europe. If Florida acquires Ryne Co., it would rely on Ryne instead of its
side business to sell its software in Europe, because Ryne could easily reach all of Florida
Company’s existing European customers and additional potential European customers. By
acquiring Ryne, Florida would be able to sell much more software in Europe than it can sell with
its side business, but it has to determine whether the acquisition would be feasible. The initial
investment to acquire Ryne Co. would be $7 million. Ryne would generate 6 million euros per
year in profits, and would be subject to a European tax rate of 40%. All after-tax profits would be
remitted to Florida Co. at the end of each year and the profits would not be subject to any U.S
taxes since they were already taxed in Europe. The spot rate of the euro is $1.10 and Florida Co.
believes the spot rate is a reasonable forecast of future exchange rates. Florida Co. expects that it
could sell Ryne Co. at the end of 3 years for 3 million euros (after accounting for any capital
gains taxes). Florida Company’s required rate of return on the acquisition is 20%. Determine the
net present value of this acquisition. Should Florida Co. acquire Ryne Co.?
ANSWER:
Year 0
Year 1
€6,000,000
€3,600,000
Year 2
€6,000,000
€3,600,000
$1.10
$1.10
Year 3
€6,000,000
€3,600,000
€3,000,000
$1.10
Cash flow to
parent, ignoring
impact on existing
business
$3,960,000
$3,960,000
$7,260,000
Impact on existing
business
–$2,000,000
–$2,000,000
–$2,000,000
Profit
After tax (40%)
Sale of company
Rate
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International Financial Management
Year 0
Cash flow to
parent,
incorporating
impact on existing
business
PV (20% discount
rate)
Initial investment
Cumulative NPV
Year 1
Year 2
Year 3
$1,960,000
$1,960,000
$5,260,000
$1,633,333
$1,361,111
$3,043,981
–$7,000,000
–$5,366,666
–$4,005,555
–$961,574
The acquisition will not be feasible, since it will require substantial initial investment, and will
also eliminate the cash flows of the existing business.
19. Foreign Acquisition Decision. Minnesota Company consists of two businesses. Its local business
is expected to generate cash flows of $1,000,000 at the end of each of the next 3 years. It also
owns a foreign subsidiary based in Mexico, whose business is selling technology in Mexico. This
business is expected to generate $2,000,000 in cash flows at the end of each of the next three
years. The main competitor of the Mexican subsidiary is Perez Co., a privately-held firm that is
based in Mexico. Minnesota Company just contacted Perez Co., and wants to acquire it. If it
acquires Perez, Minnesota would merge the operations of Perez Co. with its Mexican subsidiary’s
business. It expects that these merged operations in Mexico would generate a total of $3,000,000
in cash flows at the end of each of the next 3 years. Perez Co. is willing to be acquired for a price
of 40 million pesos. The spot rate of the Mexican peso is $.10. The required rate of return on this
project is 24%. Determine the net present value of this acquisition by Minnesota Company.
Should Minnesota Company pursue this acquisition?
ANSWER:
Additional cash flows from
acquiring Perez
Required rate of return
Present value of CF
Year 1
Year 2
$1,000,000
0.24
$806,451
$1,000,000
0.24
$650,364
Year 3
$1,000,000
0.24
$524,487
The present value = $806,451 + $650,364 + $534,487 = $1,981,303
NPV = $1,981,303 – $4,000,000 = –$2,018,697
Minnesota should not pursue the acquisition.
20. Decision to Sell a Business. Kentucky Co. has an existing business in Italy that it is trying to sell.
It receives one offer today from Rome Co. for $20 million (after capital gains taxes are paid).
Alternatively, Venice Co. wants to buy the business, but will not have the funds to make the
acquisition until 2 years from now. It is meeting with Kentucky Co. today to negotiate the
acquisition price that it will guarantee for Kentucky in two years (the price would be backed by a
reputable bank so there would be no concern about Venice Co. backing out of the agreement). If
Kentucky Co. retains the business for the next two years, it expects that the business would
generate 6 million euros per year in cash flows (after taxes are paid) at the end of each of the next
Chapter 15: Multinational Restructuring
271
two years, which would be remitted to the U.S. The euro is presently $1.20 and that rate can be
used as a forecast of future spot rates. Kentucky would only retain the business if it can earn a
rate of return of at least 18% by keeping the firm for the next two years rather than selling it to
Rome Co. now. Determine the minimum price in dollars at which Kentucky should be willing to
sell its business (after accounting for capital gain taxes paid) to Venice Co. in order to satisfy its
required rate of return.
ANSWER: To determine the minimum price in dollars at which Kentucky Co. should be willing
to sell the business two years from now, determine the NPV of its operation for the next two
years. The calculations below show the NPV of the future cash flows is $11,272,623.
Cash flow in euro
Rate
Cash flow to the parent company
PV of parent cash flows (18%
discount rate)
Cumulative NPV
Year 1
€6,000,000
$1.20
$7,200,000
Year 2
€6,000,000
$1.20
$7,200,000
$6,101,695
$5,170,928
$11,272,623
Kentucky Co. should be willing to sell its business in two years for no less than the difference
between the $20,000,000 offer today and the NPV, with an adjustment for the time value of
money:
$20,000,000 – $11,272,623 = $8,727,377
Since the money would not be received for 2 years, Kentucky Co. would need to receive a larger
amount to reflect its required rate of return on the funds over the next 2 years.
Based on an 18% required rate of return, it would take an acquisition price of $12,193,772 in two
years to equal $8,727,377 today.
21. Foreign Divestiture Decision. Baltimore Co. considers divesting its six foreign projects as of
today. Each project will last one year. Its required rate of return on each project is the same. The
cost of operations for each project is denominated in dollars and is the same. Baltimore believes
that each project will generate the equivalent of $10 million in one year based on today’s
exchange rate. However, each project generates its cash flow in a different currency. Baltimore
believes that interest rate parity (IRP) exists. Baltimore forecasts exchange rates as explained in
the table below.
a. Based on this information, which project will Baltimore be most likely to divest? Why?
b. Based on this information, which project will Baltimore be least likely to divest? Why?
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International Financial Management
Project
Country A
Country B
Country C
Country D
Country E
Country F
Comparison of One-year U.S.
and Foreign Interest Rates
The U.S. interest rate is higher
than currency A’s interest rate
The U.S interest rate is higher
than currency B’s interest rate
The U.S. interest rate is the
same as currency C’s interest
rate
The U.S. interest rate is the same
as Currency D’s interest rate
The U.S. interest rate is lower
than Currency E’s interest rate
The U.S. interest rate is lower
than Currency F’s interest rate
Forecast Method Used to
Forecast the Spot Rate One
Year from Now
Spot rate
Forward rate
Forward rate
Spot rate
Forward rate
Spot rate
ANSWER:
a. Baltimore will be most likely to divest the project in country E because it anticipates
depreciation of currency E, and no other currency is expected to depreciate. The depreciation
of the currency will reduce the dollar cash flows, so this project is less desirable than other
projects.
b. Baltimore is least likely to divest the project in country B because it anticipates appreciation
of currency B, and no other currency is expected to appreciate. The appreciation of the
currency will increase the dollar cash flows, so this project is less desirable than other
projects.
22. Factors that Affect the NPV of a Divestiture. Washington Co. (a U.S. firm) has a subsidiary in
Germany that generates substantial earnings in euros each year. One week ago, it received an
offer from a company to purchase it, and it has not yet responded to this offer.
a. Since last week, the expected stream of euro cash flows has not changed, but the forecasts of
the euro’s value in future periods have been revised downward. Will the NPV of the
divestiture be larger or smaller or the same as it was last week? Briefly explain.
b. Since last week, the expected stream of euro cash flows has not changed, but the long-term
interest rate in the U.S. has declined. Will the NPV of the divestiture be larger or smaller or
the same as it was last week? Briefly explain.
ANSWER:
a. Larger, because what the firm gives up is reduced.
b. Smaller, because the PV of what the firm gives up is increased.
Chapter 15: Multinational Restructuring
273
23. Impact of Country Perspective on Target Valuation. Targ Co. of the U.S. has been targeted by
three firms that consider acquiring it: (1) Americo (from the U.S.), Japino (of Japan), and Canzo
(of Canada). These three firms do not have any other international business, have similar risk
levels, and have a similar capital structure. Each of the three potential acquirers has derived
similar expected dollar cash flow estimates for Targ Co. The long-term risk free interest rate is
6% in the U.S., 9% in Canada, and 3% in Japan. The stock market conditions are similar in each
of the countries. There are no potential country risk problems that would result from acquiring
Targ Co. All potential acquirers expect that the Canadian dollar will appreciate by 1 percent a
year against the U.S. dollar and will be stable against the Japanese yen. Which firm will likely
have the highest valuation of Targ Co.? Explain.
ANSWER: Japan firm has lowest cost of capital, so the present value of cash flows will be
highest from that perspective.
Solution to Continuing Case Problem: Blades, Inc.
1. Using a spreadsheet, determine the NPV of the acquisition of Skates’n’Stuff. Based on your
numerical analysis, should Blades establish a subsidiary in Thailand or acquire Skates’n’Stuff?
ANSWER: (See spreadsheet attached.) The analysis indicates that the acquisition will result in a
net present value (NPV) of $6,641,949 to Blades, Inc. after accounting for the cost of the
acquisition. Thus, the establishment of a new subsidiary in Thailand would be more profitable by
$8,746,688 – $6,641,949 = $2,104,739.
2. If Blades negotiates with Skates’n’Stuff, what is the maximum amount (in Thai baht) Blades
should be willing to pay?
ANSWER: If Blades, Inc. were to negotiate with Skates’n’Stuff, it should attempt to pay a price
that would render the acquisition of Skates’n’Stuff more attractive (in terms of net present value)
than the establishment of a subsidiary. Since the difference in NPVs between the two options is
$2,104,739, Blades, Inc. should attempt to reduce the purchase price by $2,104,739/$0.023 =
91,510,391 Thai baht. Consequently, it should offer a maximum of THB1,000,000,000 –
THB91,510,391 = THB908,489,609 for Skates’n’Stuff.
3. Are there any other factors Blades should consider in making its decision? In your answer, you
should consider the price Skates’n’Stuff is asking relative to your analysis in question 1, other
potential businesses for sale in Thailand, the source of the information your analysis is based on,
the production process that will be employed by the target in the future, and the future
management of Skates’n’Stuff.
ANSWER: Yes, there are other factors Blades, Inc. should consider in reaching its decision. First,
Blades did not previously consider the acquisition of an existing business in Thailand. There may
be other, more attractive, roller blade manufacturers for sale that Blades has not yet considered.
Second, Blades should investigate the reason Skates’n’Stuff wants to sell its operations. Based on
the low price the company is asking compared to Blades’ analysis (see question 1), the
company’s outlook seems to be unfavorable. Third, the assumptions gathered by Ben Holt rely on
information from unaudited financial statements, and the accuracy of these numbers may be
questionable. Fourth, Blades should consider whether the lower quality of the roller blades
manufactured by the existing Skates’n’Stuff plant will hurt its international reputation in the long
274
International Financial Management
run, given its high-quality roller blades in the U.S. This is of particular concern if Blades is
contemplating the sale of some of the roller blades produced in Thailand in the U.S., where the
quality of its roller blades is higher.
Fifth, Blades Inc. has to consider the management of Skates’n’Stuff after the acquisition. For
example, Blades may maintain the existing employees of Skates’n’Stuff but restructure the
operations in a manner that would increase the quality of the roller blades produced there.
1. Units Sold to Retailers in Thailand
2. Price per Unit (in Thai baht)
3. Revenue from Sales to Retailers
in Thailand = (1) × (2) (in 000s)
4. Variable Cost per Unit (in Thai baht)
5. Total Variable Cost = (1) × (4) (in 000s)
6. Less Cost Savings from Production
of 108,000 Pairs in Thailand (000s)
7. Fixed Operating Expenses (in Thai
baht 000s)
8. Noncash Expense (Depreciation in
baht 000s)
9. Total Expenses = (5) – (6) + (7) +
(8) (in baht 000s)
10. Before-Tax Earnings of Subsidiary
= (3) – (9) (in baht 000s)
11. Host Government Tax (25%) (in 000s)
12. After-Tax Earnings of Subsidiary
13. Net Cash Flow to Subsidiary =
(12) + (8) (in baht 000s)
14. Thai Baht Remitted by Subsidiary
(100% of CF) (in baht 000s)
15. Withholding Tax on Remitted
Funds (10%) (in baht 000s)
16. Thai Baht Remitted After
Withholding Taxes (in 000s)
17. Salvage Value (000s)
18. Exchange Rate of Thai Baht ($)
19. $ Cash Flow to Parent = (16) × (18)
20. PV of Parent Cash Flows (25%
Discount Rate)
21. Initial $ Investment by Blades
22. Cumulative PV ($ 000s)
Year 0
280,000
4,500
Year 1
280,000
5,040
Year 2
280,000
5,645
Year 3
280,000
6,322
Year 4
280,000
7,081
Year 5
280,000
7,931
Year 6
280,000
8,882
Year 7
280,000
9,948
Year 8
280,000
11,142
Year 9
280,000
12,479
Year 10
280,000
13,976
1,260,000 1,411,200 1,580,544 1,770,209 1,982,634 2,220,551 2,487,017 2,785,459 3,119,714 3,494,079
3,500
3,920
4,390
4,917
5,507
6,168
6,908
7,737
8,666
9,706
980,000 1,097,600 1,229,312 1,376,829 1,542,049 1,727,095 1,934,346 2,166,468 2,426,444 2,717,617
3,913,369
10,870
3,043,731
32,400
32,400
—
—
—
—
—
—
—
—
—
20,000
22,400
25,088
28,099
31,470
35,247
39,476
44,214
49,519
55,462
62,117
60,000
60,000
60,000
60,000
60,000
60,000
60,000
60,000
60,000
60,000
60,000
1,027,600 1,147,600 1,314,400 1,464,928 1,633,519 1,822,342 2,033,823 2,270,681 2,535,963 2,833,079
3,165,848
232,400
58,100
174,300
263,600
65,900
197,700
266,144
66,536
199,608
305,281
76,320
228,961
349,115
87,279
261,836
398,209
99,552
298,657
453,194
113,298
339,895
514,777
128,694
386,083
583,750
145,938
437,813
661,000
165,250
495,750
747,521
186,880
560,640
234,300
257,700
259,608
288,961
321,836
358,657
399,895
446,083
497,813
555,750
620,640
234,300
257,700
259,608
288,961
321,836
358,657
399,895
446,083
497,813
555,750
620,640
23,430
25,770
25,961
28,896
32,184
35,866
39,990
44,608
49,781
55,575
62,064
210,870
231,930
233,647
260,065
289,653
322,791
359,906
401,475
448,032
500,175
558,576
1,100,000
0.01879
31,169,086
0.02300
0.02254
0.02209
0.02165
0.02121
0.02079
0.02037
0.01997
0.01957
0.01918
4,850,010 5,227,702 5,161,080 5,629,732 6,144,827 6,710,882 7,332,857 8,016,198 8,766,879 9,591,461
4,850,010 4,182,162 3,303,091 2,882,423 2,516,921 2,199,022 1,922,265 1,681,119 1,470,838 1,287,344
23,000,000
(18,150)
(13,968)
(10,665)
(7,782)
(5,265)
(3,066)
(1,144)
537
2,008
3,295
3,346,755
6,642
276
International Financial Management
Solution to Supplemental Case: Redwing Technology Company
a. The earnings performance translated in dollars is misleading because they are distorted by varying
exchange rates. The actual earnings in each local currency in each subsidiary should be assessed,
since the subsidiary has no control over the exchange rate used for translation. The translation
causes earnings to be overstated when the local currency is strong (against the dollar) and
understated when the local currency is weak. The following table shows the earnings of each
subsidiary when measured in the local currency. Based on this table, the Canadian subsidiary
experienced a consistent growth in earnings over time, averaging about a 14 percent increase per
year. Conversely, the South African subsidiary experienced consistent declines in earnings over
time, with an average annual earnings growth rate of –4.38%. The Japanese subsidiary
experienced a decline in earnings in all but one year, and its average annual earnings growth rate
was –1.03%. When measured in this way, the executive in charge of the Canadian subsidiary
appears to have achieved the best performance. The results are much different when earnings are
measured in U.S. dollars for all subsidiaries. The Canadian performance would not be as high
while the South African and Japanese performance would be higher. Yet, the chief executives of
the respective subsidiaries cannot control the translated exchange rate. It can be argued that they
should not be rewarded or penalized because of the translation effect caused by a volatile
exchange rate (although there could be exceptions when they are personally responsible for
hedging any remitted earnings or any inflows of funds coming from other countries).
Earnings (in millions) Denominated in the Local Currency
Years
Ago
5
4
3
2
1
Canada
C$16.80
19.92
22.68
25.92
28.44
Annual
Percentage
Increase
—
18.57%
13.85
14.28
9.72
South
Africa
R210.00
200.00
187.50
180.00
175.00
Annual
Percentage
Increase
—
–4.76%
–6.25
–3.74
–2.78
Japan
Y7,500.00
7,441.86
7,608.69
7,454.54
7,187.50
Annual
Percentage
Increase
—
–.77%
2.24
–2.03
–3.58
b. Based on its high annual growth rate of earnings, the Canadian subsidiary would likely deserve a
cash infusion from the parent to push for additional growth. The parent would probably feel that
its funds are more likely to generate decent returns there than in other countries.
c. Even if the earnings are remitted, Canada would still be the best bet. There was an assumption that
last year’s exchange rate would be a reasonable guess for exchange rates in future years for each
currency. This means that the parent will invest funds at the same exchange rate as the rate in
which subsidiary earnings will be converted back to dollars in the future, for each subsidiary.
Thus, no subsidiary is expected to have an exchange rate advantage over the others.
d. The earnings of the Canadian and South African subsidiaries only appear to be highly correlated
when translated in U.S. dollars. Their earnings in local currencies were not highly correlated.
Thus, some diversification benefits would be lost if the Canadian subsidiary was sold (not to
mention that it is the best-performing subsidiary) or if the South African subsidiary was sold.
Chapter 15: Multinational Restructuring
277
Small Business Dilemma
Multinational Restructuring by the Sports Exports Company
1. Are there any reasons why the business that has been so successful in the United Kingdom will not
necessarily be successful in other European countries?
ANSWER: When this business was first created, it was based on a perception that British
consumers would become more interested in U.S. football, and that American-style football would
become a popular hobby in the United Kingdom. However, Jim should consider whether the other
European countries have similar characteristics before spreading the business throughout Europe.
2. If the business is diversified throughout Europe, will this substantially reduce the exposure of the
Sports Exports Company to exchange rate risk?
ANSWER: No. The European expansion will result in payments of euros for the exports. So the
receivables will be pounds and euros, which tend to move in the same direction against the dollar.
Furthermore, the extra European business will result in a larger absolute amount of business that is
subject to exchange rate risk.
3. Now that several countries in Europe participate in a single currency system, will this affect the
performance of new expansion throughout Europe?
ANSWER: It may make it easier for the distributor to deal with stores throughout Europe, but the
Sports Exports Company will still be exposed to exchange rate risk.