W5: Hill & Hult (2022). Chapter 20

Question 1

Accounting

Answer 1

‘The language of business’ that finds expression in profit and loss statements, balance sheets, budgets, investment analyses, and tax analyses. It is shaped by the environment in which it operates, so a lack of conformity and comparability exists

Question 2

Accounting information

Answer 2

The means by which firms communicate their financial position to the providers of capital, report their income to the government, and evaluate their performance

Question 3

Financial management

Answer 3

Includes three sets of decisions: (1) investment decisions, (2) financing decisions, and (3) money management decisions

Question 4

Investment decisions

Answer 4

What activities to finance

Question 5

Financing decisions

Answer 5

How to finance those activities

Question 6

Money management decisions

Answer 6

How to manage the firm’s financial resources most efficiently

Question 7

Accounting standards

Answer 7

Rules for preparing financial statements; they define what is useful accounting information

Question 8

Auditing standards

Answer 8

Specify the rules for performing an audit

Question 9

Audit

Answer 9

The technical process by which an independent person (the auditor) gathers evidence for determining if financial accounts conform to equired accounting standards and if they are also reliable

Question 10

Transnational financing

Answer 10

Entering another country’s capital market and raising capital from stocks/bonds

Question 11

Transnational investment

Answer 11

When an investor based in one country enters the capital market of another to invest stocks or bonds

Question 12

The International Accounting Standards Board (IASB)

Answer 12

Replaced the International Accounting Standards Committee (IASC). To issue a new standard, 75% of board members must agree, which can be difficult. To get around this problem, most IASB statements provide two acceptable alternatives. Although compliance is voluntary, support for the IASB has been growing

Question 13

International Accounting Standards Committee (IASC)

Answer 13

Responsible for developing International Financial Reporting Standards (IFRS)

Question 14

European Union

Answer 14

A body that has had a substantial influence on the harmonisation of accounting standards. They mandated the harmonisation of accounting principles of its member countries

Question 15

Role of corporate headquarters

Answer 15

To control subunits within the organisation

Question 16

Budget

Answer 16

The main instrument for financial control, and the most common expression of subunits’ goals. It is typically prepared by the subunit, but it must be approved by headquarters management

Question 17

‘Corporate currency’

Answer 17

The home currency. Most international businesses require all budgets and performance data to be expressed in it. However, it also allows exchange rate changes during the year to introduce substantial distortions. A foreign subsidiary may fail to achieve profit goals because of a decline in the value of a certain curreency against the home currency. On the other hand, foreign subsidiaries’ performance can look better than it actually is because of a rise in the value of the foreign currency against the home currency

Question 18

Lessard-Lorange Model

Answer 18

Can be used to deal with distortions in subsidiaries’ performances due to exchange rate changes. Three exchange rates are used that result in nine combinations; the initial rate, the projected rate, and the ending rate. Red scenarios are disregarded. The diagonal scenarios have the advantage that the same exchange rate is used for translating both budget and performance figures into the corporate currency. A change in the exchange rate does not result in a distortion of the control process. The PP combination is preferred, in which the forward exchange rate is used

Question 19

Initial rate

Answer 19

The spot exchange rate when the budget is adopted

Question 20

Projected rate

Answer 20

The spot exchange rate forecast for the end of the budget period, i.e. the forward rate

Question 21

Ending rate

Answer 21

The spot exchange rate when the budget and performance are being compared

Question 22

Internal forward rate

Answer 22

A company-generated forecast of future spot rates

Question 23

Transfer price

Answer 23

The price at which goods and services are transferred between subsidiaries within different countries

Question 24

Foreign subsidiaries

Answer 24

Do not operate in uniform environments. Their environments have widely different economic, political, and social conditions, all of which influence the costs of doing business in a country and hence the subsidiaries’ profitability

Question 25

Manager's evaluation

Answer 25

Should be separate from the evaluation of a subsidiary. It should consider how hostile the country's environment is for that business and should be evaluated in local currency terms after making allowances for those items over which they have no control, e.g. interest/tax/inflation rates

Question 26

Capital budgeting

Answer 26

The technique financial managers use to try to quantify the benefits, costs, and risks of an investment. It has the same theoretical framework that domestic capital budgeting uses. In most cases, the cash flows are negative at first because the firm is heavily investing in production facilities. After some initial period, the cash flows will become positive as investment costs decline and revenues grow. Once the cash flows have been estimated, they must be discounted to determine NPV using a discount rate, typically the required rate of return. If the NPV > 0, the firm should go ahead with the project

Question 27

Foreign projects

Answer 27

Should be analysed from the perspective of the parent company because cash flows to the project are not necessarily the same thing as cash flows to the parent company. The project may not be able to remit all its cash flows to the parent. The parent should be interested in the cash flows it will receive, as opposed to those the project generates, because those are the basis for dividends to stockholders, investments elsewhere in the world, repayment of worldwide corporate debt, etc.

Question 28

Political risk

Answer 28

Defined as the likelihood that political forces will cause drastic changes in a country's business environment that hurt the profit and other goals of a business. High political risk means there is a high probability that change will occur in the country's political environment that will endanger foreign firms there. In extreme cases, political change may result in the expropriation of foreign firms' assets. Political and social unrest may also result in economic collapse, which can reder a firm's assets worthless, and in less extreme cases, lead to increased tax rates and price controls

Question 29

Economic risk

Answer 29

Defined as the likelihood that economic mismanagement will cause drastic changes in a country's business environment that hurt the profit and other goals of a business. The biggest problem arising from economic mismanagement has been inflation. The likelihood of this occurring decreases the attractiveness of foreign investment in a country

Question 30

Cost of capital

Answer 30

Typically lower in the global capital market by virtue of its size and liquidity than in many domestic capital markets. However, despite the trends toward deregulation of financial services, in some cases, host-country government restrictions may rule out this option. Some goverments require or prefer foreign multinationals to finance projects in their country by local debt financing or local sales of equity. Thus, in capital budgeting decisions, the discount rate must be adjusted upward to reflect limited liquidity

Question 31

Money management

Answer 31

Attempts to manage the firm's global cash resources (working capital) most efficiently. This involves minimising cash balances, reducing transaction costs, and minimising the corporate tax burden

Question 32

Transaction costs

Answer 32

The cost of an exchange. Every time a firm changes cash from one currency to another, it must bear a transaction cost. It is the commission fee it pays to the foreign exchange dealers for performing the transaction

Question 33

Transfer fee

Answer 33

Charged by most banks for moving cash from one location to another

Question 34

Multilateral netting

Answer 34

Allows a multinational firm to reduce the transaction costs that arise when many transactions occur between its subsidiaries by reducing the number of transactions. It is an extension of bilateral netting; between multiple subsidiaries within an international business

Question 35

Bilateral netting

Answer 35

When two countries cancel out their liabilities with each other

Question 36

Double taxation

Answer 36

Occurs when the income of a foreign subsidiary is taxed by the governments of both the host country and the parent company

Question 37

Tax credit

Answer 37

Allows an entity to reduce the taxes paid to the home government by the amount of taxes paid to the foreign government

Question 38

Tax treaty

Answer 38

An agreement between two countries specifying which items of income will be taxed by the authorities of the country where the income is earned

Question 39

Deferral principle

Answer 39

Specifies that parent companies are not taxed on foreign source income until they actually receive a dividend

Question 40

Tax havens

Answer 40

Used by some firms, e.g. Bahamas or Bermuda, to minimise their tax liability. It is a country with an exceptionally low, or even no, income tax. The tax haven subsidiary owns the common stock of the foreign operating subsidiaries. This allows all transfers of funds from foreign operating subsidiaries to the company to be funneled through the tax haven subsidiary. International businesses avoid or defer income taxes by establishing a wholly owned, non-operating subsidiary in the tax haven

Question 41

Unbundling

Answer 41

Relying on more than one technique for transferring funds across borders. This allows an international business to recover funds from its foreign subsidiaries without piquing host-country sensitivities with large 'dividend drains'

Question 42

Dividend remittances

Answer 42

Payment of dividens is the most common method of transferring funds. The policy on it differs per country based on tax regulations, foreign exchange risk, and the age and extent of local equity participation. In high-risk countries, subsidiaries sometimes need to speed up the transfer of funds through accelerated payments

Question 43

Royalties

Answer 43

Represent the renumeration paid to the owners of technology, patents, or trade names for the use of that technology or the right to manufacture/sell products under that name

Question 44

Royalty fee

Answer 44

A compensation for professional services or expertise supplied to a foreign subsidiary by the parent company or another subsidiary

Question 45

Transfer price

Answer 45

The price at which goods and services are transferred between entities with the firm. They can be used to position funds within an international business. At least four gains can be derived by adjusting transfer prices

Question 46

Fronting loan

Answer 46

A loan between a parent and its subsidiary channeled through a financial intermediary, usually a large international bank. Firms do so for two reasons

Question 47

Ad valorem tariff

Answer 47

A tariff assessed as a percentage of value