Block 4- ADVANCED FINANCIAL MANAGEMENT

QUESTIONS AND ANSWERS
QUESSTIONS

Question 1

• Explain the main reasons why multi-national companies (MNC) seek foreign investment.
•  Explain the types of political risks that face multi-national firms in foreign countries.
• How can a MNC protect itself against political risk?

QUESTION ONE

a)Reasons for foreign investment by MNC.

• To seek new markets for their products
• To seek growth opportunities outside their home markets
• To take advantage of tax incentives offered in other countries
• To avoid regulatory and political bottlenecks in their home country
• To diversify their operations and reduce their overall risk
• To seek new technology in form of scientific ideas for design of their products and services
• Increase production efficiency by moving to countries with low production costs.

b)Political (sovereign) risk is a probability that political event will impact adversely in the domestic and foreign firms. The host government may interfere with the operations of a MNC in a number of ways:

• Non-discriminatory interferences e.g no transfer price, non-convertibility of the currency of host nation etc.
• Discriminatory interference e.g special tax rates, government insisting on a joint venture with MNC etc.
• Discriminatory sanctions e.g. ending the right to remit or repatriate profits
• Wealth deprivation i.e takeover of a MNC by the government without any compensation.
• Anti-trust policies
• Fiscal & monetary policies e.g invest a portion of liquid cash in government to bills and treasury bonds etc.

c)Steps to minimize political risk

• Investment insurance e.g. from multi-national investment guarantee agency (MIGA)
• Forecast political interference in capital budgeting process
• Negotiation with the host government before investing
• Make prior arrangement on issues relating to transfer pricing, profit repatriation etc.
• Joint venture with the host government
• Sale of shares in the host country to raise capital
• Local supply of goods and control of marketing
• Pre-planned disinvestments and cease operations due to political interference