Chapter 15
Financing and Controlling Multinational Corporations
Chapter 15 Outline
A. Payment Terms in International Trade
B. Documents in International Trade
C. Financing Techniques in International Trade
D. Government Sources of Export Financing and Credit Insurance
E. Countertrade
F. Short-Term Financing
Chapter 15: Financing and Controlling Multinational Corporations
1
15.A Payment Terms in International Trade (1)

Five principal methods of payment in international trade (in
order of increasing risk to the exporter)
1. Cash in advance
2. Letter of credit
3. Draft
4. Consignment
5. Open account

Generally, the greater the protection afforded the exporter, the less
convenient the terms are for the importer.
Chapter 15: Financing and Controlling Multinational Corporations
2
15.A Payment Terms in International Trade (2)

Five principal means of payment in international trade,
continued
1. Cash in advance – provides the exporter the greatest protection
because
– Payment is received either before shipment or on arrival of the goods;
– Exporter’s funds are not tied up in receivables.
Used if importer’s country is politically unstable or importer’s credit is poor.
2. Letter of credit (L/C) – a letter addressed to the seller, written and
signed by a bank acting on behalf of the buyer. Satisfies both the
exporter and importer because
– The importer’s promise of payment is backed by a bank;
– The importer may not want to pay for the goods until after receipt and
inspection.
The bank promises to honor drafts drawn on itself if the seller conforms to
the conditions set forth in the L/C.
Chapter 15: Financing and Controlling Multinational Corporations
3
15.A Payment Terms in International Trade (3)

Five principal means of payment in international trade,
continued
2. Letter of credit (L/C), continued
– Advantages to the exporter
– Eliminates credit risk if the issuing bank is of undoubted standing.
– Because countries generally permit local banks to honor L/Cs,
reduces the danger of delayed or withheld payment due to exchange
controls or other political acts.
– Reduces uncertainty because all requirements are stipulated in the
L/C.
– Guards against preshipment cancellations.
– Facilitates financing by ensuring a ready buyer for the exporter’s
product.
Chapter 15: Financing and Controlling Multinational Corporations
4
15.A Payment Terms in International Trade (4)

Five principal means of payment in international trade,
continued
2. Letter of credit (L/C), continued
– Advantages to the importer
– The importer can require an inspection certificate and ascertain that
the merchandise is shipping on or before the stipulated date by
requiring an on-board bill of lading.
– Documents are carefully inspected by experienced clerks.
– An L/C is as good as cash in advance, enabling the importer to secure
more advantageous credit terms and/or prices.
– Some exporters will sell only on an L/C.
– Because the L/C substitutes for cash in advance, cash is not tied up.
– If prepayment is required, the importer is better off depositing its funds
with the bank than with the exporter because funds are easier to
recover if the exporter fails to ship the goods.
Chapter 15: Financing and Controlling Multinational Corporations
5
15.A Payment Terms in International Trade (5)

Five principal means of payment in international trade, continued
2. Letter of credit (L/C), continued
– Mechanics of an L/C – example: USA importers purchases goods from
Japan Exporters
1. Issue purchase order
USA
Importers
2. Request L/C
10.
Forward
shipping
docs
Japan
Exporters
5. Ship goods
11. Pay
L/C at
maturity
4. Notify
of L/C
6. Send
draft and 9. Send
shipping payment
docs
3. Deliver L/C
Wells Fargo
Bank
7. Send L/C, draft, shipping docs
8. Accept draft, remit funds
Chapter 15: Financing and Controlling Multinational Corporations
Bank of
Tokyo
6
15.A Payment Terms in International Trade (6)

Five principal means of payment in international trade, continued
2. Letter of credit (L/C), continued
– Types of L/Cs
– Documentary – the seller must submit necessary invoices and other
documentation with the draft
– Nondocumentary (“clean”) – L/C used for noncommercial transactions
– Revocable – L/C does not guarantee payment
– Irrevocable – payment cannot be revoked without permission of all
parties
– Confirmed – issued by one bank and confirmed by another, obligating
both banks to honor drafts drawn on the L/C.
– Unconfirmed – the obligation of the issuing bank only
– Transferable – the beneficiary has the right to instruct the paying bank
to make the credit available to one or more secondary beneficiaries
– Assignment – assigns part or all of the proceeds to another party but
does not transfer the required documents to the party.
Chapter 15: Financing and Controlling Multinational Corporations
7
15.A Payment Terms in International Trade (7)

Five principal means of payment in international trade, continued
3. Draft (bill of exchange) – an unconditional order in writing signed by the
exporter ordering the importer or importer’s agent to pay on demand or
at a fixed or determinable future date the amount specified.
– Key functions of a draft
– Provides written evidence of a financial obligation
– Enables both parties to potentially reduce their costs of financing
– Provides a negotiable and unconditional instrument
– Enables an exporter to employ its bank as a collection agent (the bank
forwards the draft to the importer, collects the funds, and remits the
proceeds to the exporter)
– Key parties to a draft
– Drawer – the party that signs and sends the draft to the second party
– Drawee – the party to whom the draft is addressed
– Payee – the party that receives the payment (often the same party as
the drawer)
Chapter 15: Financing and Controlling Multinational Corporations
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15.A Payment Terms in International Trade (8)

Five principal means of payment in international trade, continued
3. Draft, continued
– Mechanics of a draft – example: USA importers purchases goods from
Japan Exporters
Japan
Exporters
Drawer
USA
Importers
4. Pays at
maturity
Wells Fargo
Bank
Drawee*
1. Signs and
sends draft
2. Makes payment
3. Remits
proceeds
Bank of
Tokyo
Payee
*In this example, in which an L/C is used, the drawee is the confirming bank.
Chapter 15: Financing and Controlling Multinational Corporations
9
15.A Payment Terms in International Trade (9)

Five principal means of payment in international trade, continued
3. Draft, continued
– Types of drafts
– Sight draft – must be paid on presentation or else dishonored
– Time draft – payable at a specified future date
– Usance or tenor – the maturity of a time draft
– A time draft becomes an banker’s acceptance after being
accepted by the drawee.
– Banker’s acceptance (B/A) – a draft accepted by a bank
– Trade acceptance – a draft drawn on and accepted by a
commercial enterprise
– Clean draft – a draft unaccompanied by other papers, normally used
for nontrade remittances
– Documentary draft – a draft accompanied by other papers and can be
either a sight or time draft
Chapter 15: Financing and Controlling Multinational Corporations
10
15.A Payment Terms in International Trade (10)

Five principal means of payment in international trade, continued
4. Consignment
– Goods are shipped but not sold to the importer.
– Exporter (consignor) retains title to the goods until the importer (consignee)
sells them to a third party.
5. Open account
– Goods are shipped and the importer is billed later.
– No specific payment dates are set.
– Fewer bank charges than with other methods of payment.
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15.A Payment Terms in International Trade (11)

Five principal means of payment in international trade, continued
– Summary of payment methods
Payment Method
Risk
Cash in advance
L
Chief Advantage to Exporter
Chief Disadvantage(s) to Exporter
No credit extension required
Can limit sales potential
Draft
Sight draft
M/L
Retain control and title; payment before
goods are delivered
Unaccepted goods remain at port of
entry and no payment is due
Time draft
M/H
Lowers customer resistance by allowing
extended payment
Same as sight draft, plus goods are
delivered before payment is due
Banks accept responsibility to pay;
payment on presentation of papers; costs
go to buyer
If revocable, terms can change during
contract work
Facilitates delivery; lowers customer
resistance
Capital tied up until sale; credit check on
distributor; political risk insurance in
some countries; increased risk from
currency controls
Simplified procedure; no customer
resistance
High risk; seller must finance production;
increased risk from currency controls
Letter of credit
Irrevocable
M
Revocable
M/H
Consignment
M/H
Open account
H
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12
15.B Documents in International Trade (1)

Bill of lading (B/L)
– The most important shipping document
– Three primary functions
•
Contract between the carrier and shipper (exporter)
•
Shipper’s receipt for the goods
•
Establishes control over the goods
– Types of B/Ls
•
Straight – goods are consigned to a specific party, usually the importer,
and is not negotiable.
•
Order – goods are consigned to a specific party, usually the exporter.
•
On-board – certifies that the goods have been placed on board the vessel.
•
Received-for-shipment – acknowledges that the carrier has received the
goods for shipment.
•
Clean – indicates that the goods were received in good condition.
•
Foul – a clean B/L becomes foul when shipment has been damaged.
Chapter 15: Financing and Controlling Multinational Corporations
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15.B Documents in International Trade (2)

Commercial invoice
– Contains a detailed description of the goods shipped, names and
addressees of exporter and importer, number of packages,
distinguishing external marks, payment terms, other expenses, fees
collectible from the importer, name of vessel, ports of departure and
destination.

Insurance certificate
– All foreign shipments are insured.
– An open (floating) policy covers all shipments made by the exporter.
– Insurance certificate is evidence of insurance for a shipment under an
open policy.

Consular invoice
– Presented to the local consul in exchange for a visa
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15.C Financing Techniques in International Trade (1)

Banker’s acceptance (B/A)
– Time draft drawn on a bank
– By accepting the draft, the bank makes an unconditional promise to
pay the holder of the draft a stated amount on a specified day and
creates a B/A.
– The bank thus substitutes its own credit for that of the borrower.
– A B/A is a negotiable instrument.
– The accepting bank may either buy (discount) the B/A and hold it in its
own portfolio or sell (rediscount) it in the money market.
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15.C Financing Techniques in International Trade (2)

Banker’s acceptance, continued
1. Issue purchase order
USA
Importers
2. Request L/C
10.
Forward
shipping
docs
Japan
Exporters
5. Ship goods
13. Pay
L/C at
maturity
4. Notify
of L/C
6. Send
draft and
shipping
docs
9. Make
payment
3. Deliver L/C
Wells Fargo
Bank
7. Send L/C, draft, shipping docs
8. Accept draft (B/A created and discounted)
and remit funds
Bank of
Tokyo
11. Rediscount B/A
12. Remit payment for B/A
14. Present B/A at maturity
15. Send payment
Chapter 15: Financing and Controlling Multinational Corporations
Money
Market
Investor
16
15.C Financing Techniques in International Trade (3)

Banker’s acceptance, continued
–
The accepting bank receives a commission for accepting the draft and an
additional fee if an L/C is involved.
–
Evaluating costs of B/A financing – Example: assume a 90-day, $1,000,000 B/A
with a 2% annual commission fee and 9.8% 90-day discount rate
Option 1: Hold the B/A for 90 days
Face amount of B/A =
Less 2% commission = $1,000,000 * (.02/4) =
Amount received in 90 days =
$1,000,000
-$5,000
$995,000
Option 2: Sell the B/A in the money market
Face amount of B/A =
Less 2% commission = $1,000,000 * (.02/4) =
Less 9.8% annual discount = $1,000,000 * (0.98/4) =
Amount received now =
–
$1,000,000
-$5,000
-$24,500
$970,500
To understand options, compute opportunity cost of holding B/A.
Example: exporter’s opportunity cost of money is 10.2%:
•
PV of holding B/A = $995,000 / [1 + (0.102/4) = $970,258
Chapter 15: Financing and Controlling Multinational Corporations
Proceeds
from sale
of B/A >
PV of
holding B/A
17
15.C Financing Techniques in International Trade (4)

Discounting
– Even if a draft is not accepted by a bank, the exporter can convert the
draft into cash through discounting.
– Exporter places draft with a bank and receives the face value of the
draft less interest and commissions.
– If draft is insured against political and commercial risks, the interest
rate may be reduced.
– The insurer pays covered losses to exporter or any institution to which
the exporter transfers the draft.
– Discounting with recourse – the bank can collect from the exporter if
the importer fails to pay the bill when due.
– Discounting without recourse – the bank bears the risk of collection.
– Discounting is most useful for the occasional exporter and for the
exporter with a geographically diverse portfolio of receivables.
Chapter 15: Financing and Controlling Multinational Corporations
18
15.C Financing Techniques in International Trade (5)

Factoring
– An exporter sells its accounts receivable to a factor at a discount plus
fees for nonrecourse financing.
– Because most factoring is nonrecourse (i.e., factor assumes all credit
and political risks) factors may insist on purchasing all of an exporter’s
receivables to avoid a selection bias (i.e., purchasing only receivables
of risky customers).
– Evaluating the cost of factoring – Example: A factor buys an exporter’s
receivables at a 2.5% per month discount and 1.75% fee for
nonrecourse financing.
1. Compute the amount received by an exporter for factoring $1 million in
90-day receivables without recourse.
Face amount of receivable =
$1,000,000
Less 1.75% nonrecourse fee = $1,000,000 * .0175 =
-$17,500
Less 2.5% monthly discount = $1,000,000 * (0.025*3) =
-$75,000
Amount received now =
$907,500
Chapter 15: Financing and Controlling Multinational Corporations
19
15.C Financing Techniques in International Trade (6)

Factoring, continued
– Evaluating the cost of factoring – Example: A factor buys an exporter’s
receivables at a 2.5% per month discount and 1.75% fee for
nonrecourse financing, continued.
2. Compute annualized cost of factoring.
$17,500 + $75,000
$1,000,000 - $17,500 - $75,000
•
365
*
= 41.34%
90
Despite the high costs, the cost of bearing credit risk associated with
receivables can be substantially lower to a factor than to the exporter,
because
– A factor’s greater credit information gives it more knowledge about
the actual versus perceived risks involved and thus reduces its risk
premium; and
– By holding a well-diversified portfolio of receivables, the factor can
eliminate some of the risks associated with individual receivables.
Chapter 15: Financing and Controlling Multinational Corporations
20
15.C Financing Techniques in International Trade (7)

Forfaiting
– Discounting at a fixed rate without recourse of medium-term export
receivables denominated in fully convertible currencies (U.S. dollar,
Swiss franc, euro).
– Generally used for capital-goods exports with a five-year maturity and
repayment in semiannual installments.
– Fixed-rate discount ≈ 1.25% above local cost of funds.
Chapter 15: Financing and Controlling Multinational Corporations
21
15.D Government Sources of Export Financing and
Credit Insurance (1)

Most governments of developed countries provide their
domestic exporters with low-cost export financing and
concessionary rates on political and economic risk insurance.

Export financing
– Programs extending supplier credits
•
Supplier passes credit on to the importer.
•
Supplier bears the credit risk.
– Programs extending buyer credits
•
Buyer uses credits to pay the supplier.
•
Buyer bears the credit risk.
– Export-Import Bank (Eximbank)
•
U.S. government agency dedicated solely to financing and facilitating U.S.
exports.
•
Provides competitive, fixed-rate financing for U.S. export sales facing foreign
competition backed with subsidized official financing.
Chapter 15: Financing and Controlling Multinational Corporations
22
15.D Government Sources of Export Financing and
Credit Insurance (2)

Export financing, continued
– Export-Import Bank (Eximbank), continued
•
Eximbank operations
– Eximbank covers up to 100% of the U.S. component content of
exports, provided that the total amount financed does not exceed
85% of the total contract price of the item and the total U.S. content
accounts for at least half of the contract price.
– Eximbank provides financing only when private capital is unavailable.
– Loans must have reasonable assurance of repayment and must be
for projects that have a favorable impact on the country’s economic
and social well being.
– Fees and premiums for guarantees and insurance are based on the
risks covered.
– In authorizing loans, Eximbank takes into account any potential
adverse effects on the U.S. economy or balance of payments.
Chapter 15: Financing and Controlling Multinational Corporations
23
15.D Government Sources of Export Financing and
Credit Insurance (3)

Export financing, continued
– Private Export Funding Corporation (PEFCO)
•
Purchases medium- to long-term debt obligations of importers of U.S.
products at fixed rates.
•
Finances loans through the sale of its own securities.
•
Eximbank guarantees repayment of all PEFCO foreign obligations.
– Trends in public-source export financing
•
Shift from supplier to buyer credits
•
Growing emphasis on acting as catalysts to attract private capital
•
Public agencies as a source of refinancing
•
Attempts to limit competition among agencies
Chapter 15: Financing and Controlling Multinational Corporations
24
15.D Government Sources of Export Financing and
Credit Insurance (4)

Export-credit insurance
– Provides protection against losses from political and commercial risks.
– Results in lowering the cost of borrowing from private institutions
because the government agency is bearing those risks set forth in the
insurance policy.
– Foreign Credit Insurance Association (FCIA)
•
Administers the U.S. export-credit program
•
Cooperative effort of Eximbank and a group of ~50 insurance companies.
•
Short-term insurance available for export credits up to 180 days
– Comprehensive coverage covers 90% to 100% of political risks and
90% to 95% of commercial risks.
– Political-only coverage covers 90% to100% of political risks.
•
Medium-term insurance covers big-ticket credits from 181 days to five years.
– Coverage is only for that portion of the value added that originated in
the U.S.
Chapter 15: Financing and Controlling Multinational Corporations
25
15.D Government Sources of Export Financing and
Credit Insurance (5)

Taking advantage of government-subsidized export financing
– Export financing strategy
• Foreign countries in which the MNC has plants are both markets AND
potential sources of financing exports to Third-World countries.
• E.g., Massey-Ferguson wants to sell 7,200 tractors to Turkey but is unwilling
to assume risk of currency inconvertibility. Solution:
–
Massey manufactured the tractors at its Brazilian subsidiary and sold them to
Brazil’s Interbras.
–
Interbras paid Massey in cruzeiros and sold the tractors to Turkey.
–
Banco do Brazil underwrote all political, commercial, and exchange risks for
Interbras’ cruzeiro financing.
– Import financing strategy
• Many countries provide credit to foreign purchasers at below-market interest
rates and long repayment periods.
• Loans are typically tied to procurement in the agency’s country.
• If an importer can source its needs from many countries, it will have leverage
to extract more favorable financing terms from various export-credit agencies.
Chapter 15: Financing and Controlling Multinational Corporations
26
15.E Countertrade

Countertrade – a country requires exporters to purchase local
products in order to sell their products in that market.
– Countertrade results in an MNC acquiring goods that a country cannot
or will not sell in international markets.
– Goods may be unrelated to goods the MNC sells.
– An MNC must usually sell the goods acquired in countertrade at a
discount and thus may sell its exports to the country with which it
engages in countertrade at a premium to offset price reductions.
– Forms of countertrade
• Barter – a direct exchange of goods between two parties without the use of
money. E.g., oil for guns.
• Counterpurchase (parallel barter) – the sale and purchase of goods that are
unrelated to each other. E.g., soft drinks for vodka.
• Buyback – repayment of the original purchase price through the sale of a
related product. E.g., provide materials for the construction of a gas pipeline
in exchange for purchasing a certain amount of gas each year.
Chapter 15: Financing and Controlling Multinational Corporations
27
15.F Short-Term Financing (1)

Four aspects of developing a short-term foreign financing
strategy
1. Identify key factors
2. Formulate and evaluate objectives
3. Describe available short-term borrowing options
4. Develop a methodology for calculating and comparing the effective
dollar costs of options
Chapter 15: Financing and Controlling Multinational Corporations
28
15.F Short-Term Financing (2)
1.
Identify key factors – the basic determinants of any funding
strategy are strongly influenced by six key factors.
i.
If forward contracts are unavailable
–
Determine whether differences in nominal interest rates among currencies
are matched by anticipated exchange changes (i.e., whether IFE holds;
see Chapter 4).
–
If there is a deviation in IFE, expected dollar borrowing costs will vary by
currency, leading to tradeoffs between the expected borrowing costs and
the exchange risks associated with each financing option.
ii. Exchange risk
–
Borrowing locally can provide an offsetting liability if currency exposure
exists.
–
Borrowing in a local currency in which an MNC has no exposure increases
exchange risk.
Chapter 15: Financing and Controlling Multinational Corporations
29
15.F Short-Term Financing (3)
1.
Identify key factors, continued
iii. MNC’s degree of risk aversion
–
The more risk averse, the higher the price an MNC should be willing to pay
to reduce its currency exposure.
iv. If forward contracts are available
–
Currency risk should not be a factor in the MNC’s borrowing strategy.
–
Relative borrowing costs are the sole determinant of which currencies to
borrow in.
–
–
Determine whether the nominal interest differential equals the forward
differential (i.e., whether IRP holds; see Chapter 4).
–
If IRP holds, the currency denomination is irrelevant.
Given the existence or threat of government capital controls, the forward
discount or premium may not offset the difference between the interest rate
on the local currency loan versus the dollar loan (i.e., IRP will not hold).
Chapter 15: Financing and Controlling Multinational Corporations
30
15.F Short-Term Financing (4)
1.
Identify key factors, continued
v. If IRP holds before taxes
–
Currency denomination of MNC borrowings does matter when tax
asymmetries exist.
–
Tax asymmetries are based on the differential treatment of foreign
exchanges gains and losses on forward contracts and loan repayments.
–
Thus, MNCs must compute relative borrowing costs on an after-tax basis.
vi. Political risk
–
Even if local financing is not the minimum cost option, MNCs should
maximize local borrowings if they believe expropriation or exchange
controls are serious possibilities.
Chapter 15: Financing and Controlling Multinational Corporations
31
15.F Short-Term Financing (5)
2.
Formulate and evaluate objectives – four possible objectives
i.
Minimize expected cost and ignore risk – reduces information
requirements, allows borrowing options to be evaluated without
considering the correlation between loan cash flows and operating
cash flows, and facilitates break-even analysis.
ii. Minimize risk without regard to cost – this objective is impractical and
contrary to maximizing shareholder value.
iii. Trade off expected cost and systematic risk – allows the MNC to
evaluate loans without considering the relationship between loan cash
flows and operating cash flows. Probably little difference between
expected borrowing costs adjusted for systematic risk and unadjusted
borrowing costs, because the correlation between currency fluctuations
and a well-diversified portfolio is likely to be small.
iv. Trade off expected cost and total risk – provides management with
greater cash flow stability. Should be used only when forward contracts
are unavailable.
Chapter 15: Financing and Controlling Multinational Corporations
32
15.F Short-Term Financing (6)
3.
Describe available short-term borrowing options – three principal
short-term financing options
i. Intercompany loan – interest rate must fall within set limits. Relevant factors
in establishing the interest rate include the lender’s opportunity cost of
funds, tax rates and regulations, currency denomination of loan, and
expected exchange movements over the term of the loan.
ii. Local currency loan
– MNCs prefer local currency financing for convenience and exposure management.
– Bank financing
– Term loans – straight loans, often unsecured, made for a fixed period
– Line of credit (LOC) – an MNC draws down funds when required.
– Overdrafts – LOC against which drafts can be drawn.
– Revolving credit agreement – similar to an LOC except the bank is legally
committed to extend credit up to the stated maximum. The MNC pays interest
on its outstanding balance, plus a fee on the unused portion of the credit line.
– Discounting
– Nonbank financing – commercial paper and factoring
Chapter 15: Financing and Controlling Multinational Corporations
33
15.F Short-Term Financing (7)
3.
Describe available short-term borrowing options, continued
ii. Local currency loan, continued
–
Determining interest rates
Annual interest paid
Effective interest rate =
–
Funds received
Example 1 – effective rate = stated rate: an MNC borrows $10,000
for one year at 11%, with interest paid at maturity.
$1,100
Effective interest rate =
–
$10,000
= 11%
Example 2 – effective rate ≠ stated rate: an MNC borrows MXP10,000
for one year at 70%, with interest paid in advance.
MXP7,000
Effective interest rate =
Chapter 15: Financing and Controlling Multinational Corporations
MXP3,000
= 233%
34
15.F Short-Term Financing (8)
3.
Describe available short-term borrowing options, continued
ii. Local currency loan, continued
–
Compensating balance requirement – banks require borrowers to hold 10%
to 20% of outstanding loan balances in a non-interest-bearing account.
Annual interest paid
Effective interest rate =
–
Usable funds
Example 1 – an MNC borrows $10,000 for one year at 11%, with interest
paid at maturity. Compensating balance requirement = 15%.
$1,100
Effective interest rate =
–
$8,500
= 12.9%
Example 2 – an MNC borrows $10,000 for one year at 11%, with interest
paid in advance. Compensating balance requirement = 15%.
$1,100
Effective interest rate =
Chapter 15: Financing and Controlling Multinational Corporations
$7,400
= 14.9%
35
15.F Short-Term Financing (9)
3.
Describe available short-term borrowing options, continued
iii. Commercial paper (CP)
–
Short-term promissory note generally sold by large corporations on a
discount basis to institutional investors and other corporations.
–
A favored alternative to bank borrowing.
–
Average maturities vary from 20 to 25 days.
–
By going directly to the market, MNCs can save as much as 1% in interest
costs and avoid SEC registration requirements.
–
Three major non-interest costs
–
Backup LOCs – because CP maturities are very short, the issuer may not
be able to pay off or roll over maturing paper. Backup LOCs provide
insurance against this occurrence.
–
Fees to banks – MNCs must pay fees to commercial and investment
banks that act as issuing and paying agents.
–
Rating service fees – credit ratings are not legally required by any
country but are often necessary for placing CPs.
Chapter 15: Financing and Controlling Multinational Corporations
36
15.F Short-Term Financing (10)
4.
Develop a methodology for calculating and comparing the
effective dollar costs of options
–
Break-even analysis determines the effective dollar costs of a local
currency loan or dollar loan.
–
Example break-even analysis: an MNC can borrow pesos at 45% or
dollars at 11%; peso expected to depreciate by 20%
•
Analysis 1 – assume no taxes and forward contracts
–
Cost of debt kd =
kd = rL(1 + c) + c
1. Compute cost of local currency loan
kd = 0.45(1 – 0.20) – 0.20 = 16%
2. Cost of dollar loan – the cost of a dollar loan to the affiliate is the interest
rate on the dollar = 11%.
Chapter 15: Financing and Controlling Multinational Corporations
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15.F Short-Term Financing (11)
4.
Develop a methodology for calculating and comparing the
effective dollar costs of options, continued
–
Example break-even analysis: an MNC can borrow pesos at 45% or
dollars at 11%; peso expected to depreciate by 20%, continued
•
Analysis 1 – assume no taxes and forward contracts, continued
3. Set local currency and dollar interest rates equal to determine breakeven rate of currency depreciation (break-even c) at which the dollar
cost of peso borrowing is equal to the cost of dollar financing.
kd = 0.45(1 + c) + c = 11%
•
c = -23.45%
•
Thus, the peso must devalue by 23.45% before it is less expensive
to borrow pesos at 45% than dollars at 11%.
•
If c is expected to be -20%, borrow dollars.
Chapter 15: Financing and Controlling Multinational Corporations
38
15.F Short-Term Financing (12)
4.
Develop a methodology for calculating and comparing the
effective dollar costs of options, continued
–
Example break-even analysis : an MNC can borrow pesos at 45% or
dollars at 11%; peso expected to depreciate by 20%, continued
• Analysis 2 – assume taxes
– Cost of debt kd =
kd = 0.45(1 + c) + c = 11%
1. Compute cost of local currency loan given a 40% affiliate tax rate
kd = 0.45(1 + c)(1 – 0.40) + c = 0.27 + 1.27c
2. Compute cost of dollar loan – when taxes are considered, the cost of a
dollar loan to the affiliate is the after-tax interest less tax gain/loss cta.
kd = 0.11(1 – 0.40) – (-0.4c) = 6.6% + 0.4c
Chapter 15: Financing and Controlling Multinational Corporations
39
15.F Short-Term Financing (13)
4.
Develop a methodology for calculating and comparing the
effective dollar costs of options, continued
–
Example analysis: an MNC can borrow pesos at 45% or dollars at
11%; peso expected to depreciate by 20%, continued
•
Analysis 2 – assume taxes, continued
3. Set local currency and dollar interest rates equal to determine breakeven rate of currency depreciation at which the dollar cost of peso
borrowing is equal to the cost of dollar financing.
0.066 + 0.4c = 0.27 + 1.27c
•
c = -23.45%
•
The break-even exchange rate is the same as in Analysis 1.
•
Thus, although taxes affect the after-tax costs of the dollar and
local currency loans, if one loan has a lower cost before tax, it
will also be less costly on an after-tax basis.
Chapter 15: Financing and Controlling Multinational Corporations
40
15.F Short-Term Financing (14)
4.
Develop a methodology for calculating and comparing the
effective dollar costs of options, continued
–
Example analysis: an MNC can borrow pesos at 45% or dollars at 11%;
peso expected to depreciate by 20%, continued
•
Analysis 2 – assume taxes, continued
•
Thus, in general, the break-even rate of currency appreciation or
depreciation can be found by equating the dollar costs of local currency
and dollar financing and solving for c:
rH(1 – ta) + cta = rL(1 + c)(1 – ta) + c
Chapter 15: Financing and Controlling Multinational Corporations
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