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? 4. Valuation of a Private Target 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 prices of most Russian companies rose substantially just prior to Rastell’s assessment of the target. If Rastell, Inc., acquires a private target in Russia, will it be able to avoid the impact of the high stock prices on business valuations in Russia? 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 be lower if Asia experienced a new crisis. 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 for $60 million in cash, and the offer is still available this week as well. The annualized long-term risk-free rate in the United States increased from 7 to 8 percent this week. The expected monthly cash flows to be generated by the subsidiary have not changed since last week. The risk premium that Merton applies to its projects in Bulgaria was reduced from 11.3 to 10.9 percent this week. The annualized long-term risk-free rate in Bulgaria declined from 23 to 21 percent 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.)
2. Country Risk Assessment Describe the steps involved in assessing country risk once all relevant information has been gathered.
7. Country Risk Analysis Niagara, Inc., has decided to call a well-known country risk consultant to conduct a country risk analysis in a small country where it plans to develop a large subsidiary. Niagara prefers to hire the consultant since it plans to use its employees for other important corporate functions. The consultant uses a computer program that has assigned weights of importance linked to the various factors. The consultant will evaluate the factors for this small country and insert a rating for each factor into the computer. The weights assigned to the factors are not adjusted by the computer, but the factor ratings are adjusted for each country that the consultant assesses. Do you think Niagara, Inc., should use this consultant? Why or why not?
13. Reducing Country Risk MNCs such as Alcoa, DuPont, Heinz, and IBM donated products and technology to foreign countries where they had subsidiaries. How could these actions have reduced some forms of country risk?
16. How Country Risk Affects NPV Hoosier, Inc., is planning a project in the United Kingdom. It would lease space for 1 year in a shopping mall to sell expensive clothes manufactured in the United States. The project would end in 1 year, when all earnings would be remitted to Hoosier, Inc. Assume that no additional corporate taxes are incurred beyond those imposed by the British government. Since Hoosier, Inc., would rent space, it would not have any long-term assets in the United Kingdom and expects the salvage (terminal) value of the project to be about zero.
Assume that the project’s required rate of return is 18 percent. Also assume that the initial outlay required by the parent to fill the store with clothes is $200,000. The pretax earnings are expected to be £300,000 at the end of 1 year. The British pound is expected to be worth $1.60 at the end of 1 year, when the after-tax earnings are converted to dollars and remitted to the United States. The following forms of country risk must be considered:
The British economy may weaken (probability = 30 percent), which would cause the expected pretax earnings to be £200,000.
The British corporate tax rate on income earned by U.S. firms may increase from 40 to 50 percent (probability = 20 percent).
These two forms of country risk are independent. Calculate the expected value of the project’s net present value (NPV) and determine the probability that the project will have a negative NPV.