Lesson Six Homework

100 Points

Q1: Some MNCs establish a manufacturing facility where there is a relatively low cost of
labor, but they sometimes close the facility later because the cost advantage dissipates.
Why do you think the relative cost advantage of these countries is reduced over time?
(Ignore possible exchange rate effects.)

As MNCs capitalize on the benefits of locating facilities where there is a relatively low cost
of labor, they can potentially create a stronger demand for labor in that area. The stronger
demand for labor can cause labor shortages, as well as an increase in the wage rate.
Therefore, reducing any cost advantage.

Q2: DFI Strategy. JCPenney has recognized numerous opportunities to expand in foreign
countries and has assessed many foreign markets, including Brazil, Greece, Mexico,
Portugal, Singapore, and Thailand. It has opened new stores in Europe, Asia, and Latin
America. In each case, the firm was aware that it did not have sufficient understanding
of the culture of each country that it had targeted. Consequently, it engaged in joint
ventures with local partners who knew the preference of the local customers.

a. What comparative advantage does JCPenney have when establishing a store in a

foreign country, relative to an independent variety store?

JCPenney has name recognition, which could result in customer trust, and therefore lead
to stronger demand for its products. They also have marketing expertise that applies to
each store. As well, they have economies of scale, because it can buy its products in bulk
and distribute the specific needs for those products.

b. Why might the overall risk of JCPenney decrease or increase as a result of its recent
global expansion?

Its risk may decrease because it has a strategy that allows it to utilize its expertise while
relying on foreign expertise for part of the business that requires knowledge about foreign
cultures. As well, it has created more international diversification by spreading its store
throughout more foreign markets, so that U.S. economic conditions do not as heavily
influence its overall performance.

c. JCPenney has been more cautious about entering China. Explain the potential
obstacles associated with entering China.

Obstacles can include various economic factors such as high inflation in China,
difficulties in converting foreign currency, difficulties in efficiently distributing products
across stores, and the lack of disposable income for many china residents.
Q3: Huskie Industries, a U.S.-based MNC, considers purchasing a small manufacturing
company in France that sells products only within France. Huskie has no other existing
 business in France and no cash flows in euros. Would the proposed acquisition likely be
more feasible if the euro is expected to appreciate or depreciate over the long
run? Explain.

Appreciation of the Euro is the most favorable since the euro inflows would someday be
converted to more U.S. dollars. Therefore, will be an increase in the annual cash flows and
earnings from the realization of salvage value to be received by the company The cash flows
received by the company are subject to the exchange rate and also the time value of money for
computing the present value which may differ from year to year. Future depreciation of the euro
would be unfavorable since the weekend euro would convert to fewer u.s. Dollars over time.
There will be a decrease in the annual cash flows and proceeds from the realization of salvage
value to be received by the company. Therefore, the proposed acquisition would be more feasible
if the euro appreciates for the long run.

Q4: When Walt Disney World considered establishing a theme park in France, were the
forecasted revenues and costs associated with the French park sufficient to assess the
feasibility of this project? Were there any other “relevant cash flows” that deserved to
be considered?

Forecasted revenues and costs themselves are not sufficient enough to assess the feasibility
of the project. It should also consider depreciation on equipment, withholding taxes by the
foreign government, cash flows remitted to the parent by the subsidiary, salvage value of the
equipment. The additional relevant cash flows that should be considered for this project are
the grants from the foreign government for the theme park, and reduction in withholding
taxes.

Q5: Brower, Inc. just constructed a manufacturing plant in Ghana. The construction cost 9
billion Ghanian cedi. Brower intends to leave the plant open for three years. During the
three years of operation, cedi cash flows are expected to be 3 billion cedi, 3 billion cedi,
and 2 billion cedi, respectively. Operating cash flows will begin one year from today and
are remitted back to the parent at the end of each year. At the end of the third year,
Brower expects to sell the plant for 5 billion cedi. Brower has a required rate of return
of 17 percent. It currently takes 8,700 cedi to buy one U.S. dollar, and the cedi is expected
to depreciate by 5 percent per year.

a. Determine the NPV for this project. Should Brower build the plant?
Year 0 1 2 3
Investment -9,000,000,000
OCF 3,000,000,000 3,000,000,000 2,000,000,000
Salvage value 5,000,000,000
NET Cash -9,000,000,000 3,000,000,000 3,000,000,000 7,000,000,000
Flow
Exchange rate 8,700 9,135 9,592 10,071
 Cash flow to –1,034,483 328,407.23 312,760.63 695,065.04
company
PV of company -1,034,483 280,689.94 228,475.88 433,978.15
cash flows
NPV -1,034,483 -753,793.06 -525,317.18 -91,339.03

Because the project has a negative net present value, the company should not undertake it

b. How would your answer change if the value of the cedi was expected to remain
unchanged from its current value of 8,700 cedis per U.S. dollar over the course of the
three years? Should Brower construct the plant then?

Year 0 1 2 3
Investment -9,000,000,000
OCF 3,000,000,000 3,000,000,000 2,000,000,000
Salvage value 5,000,000,000
NET Cash -9,000,000,000 3,000,000,000 3,000,000,000 7,000,000,000
Flow
Exchange rate 8,700 8,700 8,700 8,700
Cash flow to –1,034,483 344,827.59 344,827.59 804,597.70
company
PV of company -1,034,483 294,724.44 251,901.23 502,367.11
cash flows
NPV -1,034,483 -739,748.56 -487,847.33 14,519.78

If the value of the cedi remains constant, the NPV is positive. Thus, Brower should undertake the
project in this case. Of course, the NPV is only slightly positive. Whether or not Brower actually
undertakes the project depends on the confidence it has in its exchange rate forecasts.