Cash Management

09/12/2008 Dr.Tomy Mathew 1

International Financial Management


Issues of IFM

Investing DecisionsFinancing DecisionsMoney Management Decisions


Investing Decisions

Capital BudgetingProject and Parent Cash FlowIncorporating Risk

Political RiskEconomic Risk


Capital Budgeting Process

1. Future cash inflows are estimated2. Appropriate discount rate is determined3. Estimated future cash inflows are

discounted4. Present value of future cash inflows are

compares with the cost of the project5. Projects arte ranked in the order of Net

Present Value6. Project with the highest NPV is selected


Multinational Capital Budgeting. Features1. Involves multiple currencies2. Involves multiple tax rates and tax

systems3. Subject to foreign political risk4. Subject to capital flow restrictions5. Project specific subsidies provided by the

host government6. Project specific penalties imposed by the

host government7. Restrictions on repatriating income


MCB – Two perspectives

Perspective of the parentPerspective of the subsidiary

The cash flow under the two perspectives will be different So the feasibility of the project changes with the change in the perspective.


Reasons for Change in Cash Flow1. Existence of Tax Differences:-

If tax rates on fund remittances are high, the project may be feasible from the view point of the subsidiary and may not be viable form the point of view of the parent

2. High Fees:When the parent charges high fees from the subsidiary, the net income of the subsidiary decreases and therefore it become unviable from subsidiaries perspective, but viable from parent’s perspective


Reasons for Change in Cash Flow3. Remittance Restrictions:-

When there are restrictions on remittances, the project becomes unviable from parent’s perspective though viable from ht perspective of the subsidiary

4. Exchange Rate variations:- If the parent's currency appreciates, the amount remitted to the parent may decline (in terms of parent’s currency) and the project becomes unviable, though it is viable in the perspective of the subsidiary


Reasons for Change in Cash Flow

5. Effect on sales of other divisions:

Because of the foreign investment the existing export of a multinational firm decrease. While evaluating the project from the perspective of the parent the loss due to decline in exports also should be considered


Capital Budgeting TechniquesPayback period (PBP)Average Rate of Return (ARR)Net Present Value (NPV)Profitability Index (PI)Internal Rate of Return (IRR)


Net Present Value (NPV)It is the most popular method of project evaluationThe present value of future cash inflows are compared with the cost of the project


NPV for International Evaluation

International projects have certain special features such as blocking of funds, Cannibalization and sales creation, different levels of taxation, opportunity cost, transfer pricing, fees and royalties, etc.,The major draw back in using NPV for evaluation of international projects is that the risk perceptions of various types of cash flows cannot be incorporated


Adjusted Present Value(APV)In APV technique, the complexities found in investment overseas are separately accounted for.In this method each type of cash flow is discounted separately using different discount rates


Incorporating Risk

To incorporate political and economic risk –A higher discount rate is generally used


Financing Decisions

Source of FinancingForeign Issue, Euro Issue

Financial Structure Debt-Equity Composition

Method FinancingDepository Receipts, Equity, Bond, FCCB, ECB


Global Money ManagementObjectives

EfficiencyTax


Efficiency ObjectivesMinimising cash balanceReducing Transaction Cost


Attaining the ObjectivesDividend remittancesRoyalty paymentsTransfer pricesFronting Loans (A loan between a parent and its subsidiary channelled through a financial intermediary)


TechniquesCentralised DepositoriesMultilateral Netting


Cash ManagementCash flow management is a part of short term financial managementIt is an integral part of international financial management


Cash Management - Objectives1. To allocate short-term

investments and cash balance holdings between currencies and countries to maximize overall corporate returns

2. To borrow in different money markets to achieve the minimum cost

3. Reduce the tax


Cash Management – Two broad issues

1. The Investment and Borrowing Criteria

Whether a company should invest or borrow in domestic versus foreign currency

2. Centralised Vs. Decentralised cash management

• Whether a company with receipts and payments in different countries and currencies should manage working capital locally or centrally


The Investment and Borrowing Criteria Factors to be considered

1. The expected change in the foreign exchange rate

2. The current and future interest rate

3. The transaction cost


The Investment and Borrowing

Determining the currency of investmentDetermining the currency of borrowing


Determining the currency of investment

Investors should be indifferent between home- and foreign-currency denominated securities, if

the home-currency interest rate equals the foreign-currency interest rate plus the annualised forward exchange premium/discount on the foreign currency


Determining the currency of investment

Investors should invest in the home currency

when the domestic-currency interest rate exceeds the sum of the foreign –currency rate plus the forward exchange premium/discount

and invest abroad when the domestic currency rate is less than this sum


Determining the currency of borrowing 1

The borrowing criterion is the same as the investment criterion with the inequality reversed. That is,Borrowers should be indifferent between home- and foreign-currency denominated securities if

the home-currency interest rate equals the foreign-currency interest rate plus the annualised forward exchange premium/discount on the foreign currency


Determining the currency of borrowing 2

Borrowers should borrow in the home currency

when the domestic-currency interest rate is less than the sum of the foreign –currency rate plus the forward exchange premium/discount and

borrow from abroad when the domestic currency rate is higher than this sum


Impact of Transaction cost on borrowing and lending

Transaction costs on foreign exchange tend to favour the choice of domestic currency investments

Levi 419Foreign currency borrowings are discouraged by borrowing-lending spreads

Levi 421


Centralised Vs. Decentralised Cash management

A multinational corporation with subsidiaries in different parts of the world may have cash flows in a variety of currencies and countries.It can leave cash management to

individual subsidiaries or have a centralised cash management system


Advantages of Centralised Cash management System

NettingLeading and LaggingCurrency DiversificationPoolingSecurity Availability and Efficiency of Collections


NettingNetting involves

the cash management centre nets out receivables against payables, and only the net cash flows are settled among different units of the corporate family

Netting need not be confined to intra-corporate transactions. Transactions with third parties can also be incorporated


Leading and Lagging

Leading and lagging involves the movement of cash inflows and outflows forward and backward in time so as to permit netting and achieve other goals

The opportunities for leading and lagging are limited by preference of the other partyWhen transactions are between divisions of the same multinational the scope for leading an lagging is considerable


Currency DiversificationA portfolio of inflows and outflows in different currencies will have a smaller variance of value than the sum of variances of the values of the individual currencies.The adverse effect from exchange rate variations in one currency will more or less will be compensated by the favourable variations in the exchange rate of one or more other currencies


Pooling1. Pooling occurs when cash is held as well as

managed centrally2. The advantage of pooling is that cash needs

can be met wherever they occur without having to keep precautionary balances in each country

3. Uncertainties and delays in moving funds to where they are needed require that some balance be maintained everywhere

4. With pooling, a given probability of having sufficient cash to meet liquidity needs can be achieved with smaller holdings.


Security Availability and Efficiency in Collections

If the centralisation occurs in a major international financial center like London or New York, there are additional advantages in terms of:

1. A broader range of securities that are available and

2. An ability to function in an efficient financial system


Disadvantages of Centralised Cash management

Some funds have to be held in each subsidiary to meet unforeseen payments since banking system in many developing countries do not permit rapid transfers of fundsSome payments are to be made on the spot for which purpose local banks have to be used and local banking relationships are essential


Factors affecting the Location of Cash

Factor Implication

Absence of Forward markets

Keep funds in the currency received if an anticipated future need exists

Transaction costs Keep funds in the currency received

Political risk Move funds to the home market

Liquidity needs Keep funds in the currency most likely to be needed in the future

Withholding tax Avoid countries whose withholding rates exceed the domestic tax rate


Tax IssueDouble Taxation (Tax paid in both the countries)Tax on repatriation (Tax on only that incomer which is transferred to another country)


Assignment

Read the closing case in P.856 and prepare a write up in two pagesRead question No.4 in page 855 and write an answer in one page

Date of submission – 13/12/2008

Cash Management

Documents

tomy mathew

perspective dr

ecb09122008 dr

considered09122008 dr

parent cash flow

cash flow1

cash flow3

cash flow5