Loreal

Ch 12: Answers to End of Chapter Questions

1. Reducing Economic Exposure.

ANSWER: Baltimore Inc. could reduce its economic exposure by shifting some of its U.S. expenses to Europe. This may involve shifting its sources of materials or even part of its production process to Europe. It could also reduce its European revenue but this is probably not desirable.

2. Reducing Economic Exposure.

ANSWER: UVA Company has periodic outflow payments in Thai baht that are substantially more than its Thai baht inflow payments. UVA could reduce its economic exposure by attempt¬ing to increase sales in Thailand, which would generate additional Thai baht inflows.

3. Reducing Economic Exposure.

ANSWER: Albany may ask the Australian government to provide payment in U.S. dollars. Alternatively, Albany could attempt to shift some of its expenses to Australia, by either purchasing Australian supplies or shifting part of the production process to Australia. These strategies will increase Australian dollar outflows, so that the Australian dollar inflows and outflows are more balanced.

4. Tradeoffs When Reducing Economic Exposure.

ANSWER: An MNC may attempt to use several production plants. The production could be increased in countries whose home currency is weak (since demand for products in those countries would be higher). However, to have such flexibility requires that production plants are scattered. Consequently, the firm forgoes the economies of scale that may be achieved by establishing one large production plant.

5. Exchange Rate Effects on Earnings.

ANSWER: A U.S. based MNC's consolidated earnings are reduced by the translation effect when foreign currencies depreciate. Foreign earnings are translated at the average exchange rate over the fiscal year, so low values of foreign currencies result in a low level of consolidated earnings.

9. Comparing Degrees of Economic Exposure.

ANSWER: Carlton Company is subject to a higher degree of economic exposure because it does not have much offsetting cost in Mexico. Palmer Inc. incurs costs in Mexico for its research and development center.

10. Comparing Degrees of Translation Exposure.

ANSWER: Since Nelson Company does not have any subsidiaries, its exposure to exchange rate fluctuations would not be classified as translation exposure. Conversely, Mez Company is subject to translation exposure.

Chapter 17: Answers to End of Chapter Questions

1. Capital Structure of MNCs.

ANSWER: MNCs that are well diversified across countries would have somewhat stable cash flows and may therefore be able to handle a high level of debt. They may use substantial foreign debt financing to reduce their subsidiary exposure to exchange rate risk and country risk.

MNCs that are highly exposed to exchange rate movements or have subsidiaries located in politically unstable countries may experience very volatile cash flows. These MNCs could not handle high periodic debt payments and may be better off with an equity-intensive capital structure.

2. Optimal Financing.

ANSWER: Wizard should use financing by local banks in the foreign country, so that the subsidiary can make use of its funds by paying off local debt.

4. Local Versus Global Capital Structure.

ANSWER: A particular country's characteristics can cause the MNC's subsidiary to use mostly debt or mostly equity, even if the MNC's "global" target capital structure is more bal¬anced. For example, if the country's stock market is not well developed, the MNC may prefer not to issue stock there, as an inactive secondary market may make it difficult to place stock in that country. In this case, the subsidiary may be financed mostly with debt (such as loans from local banks).

5. Cost of Capital.

ANSWER: The following characteristics of MNCs can influence the cost of capital:

* Size. MNCs have more opportunities to grow, and larger, better known firms may receive preferential treatment by creditors.

* Access to international capital markets. MNCs have access to more sources of funds than domestic firms. To the extent that financial markets are segmented, MNCs may be able to obtain financing from various sources at a lower cost.

* International diversification. If MNCs can achieve more stable cash flows through their international diversifi¬cation, their probability of bankruptcy is reduced. Creditors and shareholders may therefore accept a lower rate of return when providing funds to the MNCs, which reflects a lower cost of capital for MNCs.

* Exchange rate risk. MNCs that are highly exposed to exchange rate movements may be more likely to experience financial problems (if they do not hedge the risk). Thus, they may incur a higher cost of capital.

* Country risk. MNCs with subsidiaries in politically unstable countries may experience volatile cash flows over time and be more susceptible to financial problems. Thus, they may incur a higher cost of capital.

7. Target Capital Structure.

ANSWER: LaSalle Corporation can use mostly equity financing for its U.S. operations. When consolidated with the debt financ¬ing of its subsidiaries, its "global" target capital structure is balanced. The heavy emphasis on equity financing in the U.S. offsets the heavy emphasis on debt financing in the foreign countries.

8. Financing Decision.

ANSWER: Drexel should let local banks support the subsidiary since it would be in the interest of the banks to see that the subsidiary performs well. If the host government imposed restrictions that reduced the subsidiary's profits, the banks could be adversely affected as well.

Financing from the MNC parent would not provide such protection since the local banks would have less interest in protecting the subsidiary from host government restrictions.

11. Costs of