ࡱ> kmhij` bjbj o~!TLhtL|t4$hXz!LLL!6LLC܄ V(z"TL0|ݴfDCC\ŌD C!!hX|LLLLLLLaPiLLLPiLLL CHAPTER 12 STRATEGIC ACCOUNTING ISSUES IN MULTINATIONAL CORPORATIONS Chapter Outline I. The strategic issues faced by a MNC are related to strategy formulation and strategy implementation. A. Strategy formulation is the process of deciding on the goals of the organization and plans for attaining those goals, whereas strategy implementation refers to the process by which managers influence others within the organization to behave in accordance with those goals. B. Capital budgeting is an important activity associated with strategy formulation, and strategies are implemented mainly through operational budgeting and performance evaluation. Accounting plays a major role in these activities as a source of information. II. Accounting provides quantitative information about (a) opportunities and threats as well as strengths and weaknesses, and (b) costs and benefits needed for long-term investment (or capital budgeting) decisions. A. Techniques such as payback period, return on investment (ROI), net present value (NPV), and internal rate of return (IRR) are employed in making long-term investment decisions. B. All capital budgeting techniques compare estimates of future cash flows with the cost of the investment. C. NPV and IRR take the time value of money into consideration by calculating the present value of future cash flows in evaluating potential capital investments. D. Preferences for using particular capital budgeting techniques vary across countries due to cultural and other reasons. E. In calculating future cash flows from foreign investments, MNCs should consider various risks associated with them, namely, political risk, economic risk, and financial risk. F. MNCs tend to evaluate foreign investments from both project and parent viewpoints. III. Accounting provides tools for implementing strategies and monitoring their effectiveness through the development of operating budgets. A. Operating budgets help express a firms long-term strategy within shorter time frames and specify criteria for monitoring progress. B. It is important for MNCs to translate operating budgets of foreign subsidiaries using an appropriate exchange rate. IV. Accounting provides tools for evaluating organizational effectiveness in fulfilling its objectives, and at the same time for motivating organizational members to behave in a manner consistent with the organizations goals. A. The level of performance depends on many factors, and no single measure can incorporate all of them. Therefore, it is common for MNCs to use a mixture of measures, financial and non-financial, formal and informal, and formula-based and subjective in evaluating performance. B. MNCs do not seem to use any particular measure consistently for evaluating performance. V. Performance evaluation in MNCs is complicated by exchange rate fluctuations, varying rates of inflation in foreign countries, international transfer pricing, and cultural and environmental differences that exist across countries. A. A potential problem for MNCs is the tendency for headquarters to rely on simple financial control systems, often designed for home country operations and extend them to foreign subsidiaries. B. The financial measures used to evaluate performance, such as sales growth, cost reduction, profit and return on investment, are provided through the accounting system. C. MNCs also use non-financial measures, such as market share, relationship with host country government, to evaluate performance, and such measures are not based on information obtained directly from financial statements. VI. The method of evaluation used depends largely on the type of subsidiary involved, for example, its strategic role within the MNC and its organizational culture. VII. The importance of non-financial measures in evaluating performance is reflected in the growing popularity of the balanced scorecard approach, focusing on integrating the key elements of a business, vision strategy, and four perspectives, namely, financial, customer, internal business process, and learning and growth. VIII. In evaluating the performance of a foreign subsidiary, important questions include: whether to separate managerial performance from the unit performance; and how to separate controllable items and non-controllable items. Answers to Questions A strategy indicates the general direction in which a firm plans to move to attain its goals. The strategies of any business organization, whether purely domestic or multinational, are determined by matching two key ingredients: core competencies and available opportunities. Internal factors relate to the identification of core competencies of a firm focusing on strengths and weaknesses with regard to the expertise available within the firm in the areas of technology, manufacturing, distribution, and logistics. A strategy indicates the general direction in which a firm plans to move to attain its goals. The strategies of any business organization, whether purely domestic or multinational, are determined by matching two key ingredients: core competencies and available opportunities. The external factors relate to the identification of the opportunities available to the firm, the second key ingredient in formulating strategy. Identification of opportunities also includes the threats facing the firm in the areas of competitors, customers, suppliers, regulatory bodies, as well as socio-political circumstances. Accounting provides the skills necessary to quantify in financial terms the factors that influence strategy formulation -- strengths, weaknesses, opportunities and threats --, and to develop projections of costs and benefits as financial expressions of strategy. Capital budgets are a prime example of the contribution accounting makes in strategy formulation. Further, organizational goals are often expressed in financial terms, for example, to achieve a particular level of return on investment. Both NPV and IRR are discounted cash flow techniques (recognizing the time value of money) used for evaluating capital investment proposals. The NPV method uses a discount rate (usually, the firms cost of capital) to restate all future net cash inflows in terms of their present values to be compared with the initial investment, while the IRR method identifies the discount rate that equates the cash outflows and inflows of a proposed investment project. In other words, the NPV method indicates whether or not a particular proposed investment is capable of generating a desired rate of return, and the IRR method indicates the exact return that can be expected from a proposed investment. The NPV method allows the use of a realistic discount rate for reinvestment, whereas the IRR method might not. The IRR method facilitates comparison of projects requiring different amounts of investments, whereas the NPV method is not helpful in comparing projects requiring different amounts of investments. Another weakness of the NPV method is that it tends to favor large investments. A weakness of the IRR method is that its assumption on reinvestment rate of return could be unrealistic. The organizational structure of a MNC is determined to a considerable extent on the roles assigned to its subsidiaries. Some subsidiaries play the role of a producer of products for the parent company, where as others have catering for the needs of the host country market as their main role. There are also subsidiaries that operate as part of a global network. Attainment of corporate goals is the main objective of implementing strategy. The subsidiary managers contributions towards this end will depend on the roles assigned to each subsidiary within the organizational structure. For example, the contribution expected from the manager of a subsidiary that plays the role of an integrated player would be different from that expected from the manager of a subsidiary that focuses mainly on catering for the host country market. Due to cultural differences across countries, corporate managers may have to tailor the manner in which strategy is implemented in a specific country in order to achieve the desired results. For example, a management control tool such as standard costing that assumes that the responsibility for specific tasks lies with the individual who is traceable may not be effective in a cultural context such as Japan where a group, rather than an individual, is assigned responsibilities. Further, the managers of a subsidiary located in a strong uncertainty avoidance society can be expected to create more slack in preparing budgets as a method of dealing with future uncertainty, compared to managers of a subsidiary located in a weak uncertainty avoidance society. In implementing multinational strategy it is important to ensure that the managers and other members of foreign subsidiaries are motivated to behave in accordance with corporate goals. However, people from different cultural backgrounds may respond differently, for example, to financial incentives. The role of accounting in implementing multinational business strategy is to assist the process by which managers influence other members of the organization. Accounting fulfills this role primarily through the budgeting process, in particular, operational budgeting. An operating budget is a financial expression of a firms long-tern strategy within a shorter time frame, usually one year. It helps plan what the organization should do to effectively implement strategy, coordinate the activities of several parts of the organization, communicate information to organizational members, and evaluate information. Budgeting also offers tools for monitoring progress. In addition, accounting provides the skills necessary to deal with the effects of exchange rate changes and foreign inflation in implementing corporate strategy. Performance evaluation is a part of the process by which managers influence other members of the organization. Accounting plays an important role in this regard in providing targets which are used in evaluating performance. One of the main issues in designing an appropriate performance evaluation system for a foreign affiliate relates to the selection of the criteria to be used in evaluating performance. This is critical because correctly selected criteria can act as a motivating factor within the unit. However, if not done carefully, evaluation criteria can have dysfunctional effects. Firms often use a mixture of financial measures, such as profit and ROI, and nonfinancial measures, such as market share and customer satisfaction, in evaluating the performance of foreign operations. When profit is used as part of the measure of performance, a decision has to be made as to how it should be calculated. For example, should it be calculated using host country or parent company accounting principles. Another issue that must be resolved is how to treat a foreign unit for performance evaluation purposes. For example, the measures used to evaluate the performance of a unit treated as a cost center would be different from those used for a unit that is treated as an investment center, because the level of responsibility given to the manager of an investment center is much higher compared to that given to a cost center manager. A related issue is whether to evaluate the unit and the manager using the same criteria or to use different sets of criteria to evaluate the manager and the unit. The main concern here is that the manager of a unit should not be held responsible for decisions, which are beyond his or her control. This is often known as the controllability principle. It is possible that the manager has performed well despite the poor performance of the unit. All these issues are also common to a group that only has local affiliates. However, each one of the issues mentioned above is complicated by changes in exchange rates and interest rates as well as other issues related to foreign inflation. Survey results clearly show that there are variations in the evaluation methods adopted by Japanese and U.S. MNCs. These variations are most likely due to cultural differences. For example, Bailes and Asadas 1991 survey found that the most frequently used performance measure by U.S. MNCs was ROI, whereas ROI was relatively unimportant for Japanese MNCs. On the other hand, the most frequently used measure by Japanese MNCs was sales volume, whereas it was relatively much less important for U.S. MNCs. Another interesting finding of that survey is the high importance given to production costs by Japanese MNCs as a performance evaluation measure, in contrast to how it was viewed by U.S. MNCs. MNCs often use financial measures in evaluating foreign subsidiary performance, mainly due to the fact that the information is readily available from the financial statements. However, now there is increasing recognition that focusing on financial information alone is not sufficient in evaluating a firms performance. Nonfinancial measures that can be used to evaluate the performance of a foreign subsidiary include (but are not limited to): growth in market share, relationship with host country government, cooperation with corporate management and peer units, ability to maintain an appropriate level of employee morale and to retain skilled employees, improvement in productivity, product innovation, customer service, research and development, and social/environmental sensitivity. The factors that influence the manner in which a particular subsidiary should be treated include the strategic role assigned to the subsidiary, and the level of responsibility given to its management. For example, if the role assigned to a particular subsidiary only requires it to produce as much as possible at a specified level of quality with a fixed amount of resources, then it would be treated as a cost center as its main focus would be cost control. If the subsidiarys managers were expected to determine product prices, market the products, and achieve sales growth, then their responsibilities would be greater. In this case, the subsidiary would have the responsibility for both costs and revenues, and as such it should be evaluated as a profit center. If, in addition to managing costs and revenues, the subsidiary manager were also given the responsibility for making investment decisions, then such a subsidiary would be treated as an investment center. Investment center managers have the highest level of responsibility. It is important to separate the performance of a subsidiary from that of its management for evaluation purposes, mainly because the performance of a subsidiary can be influenced by decisions made by corporate management and other parties, events that are beyond the control of subsidiary management. Examples of items that are not controllable by local management are transfer-pricing decisions made by corporate headquarters and a general labor strike, which can affect both the costs and revenues of the subsidiary. It would not be fair to include the effects of these factors in measuring the performance of the subsidiary manager, as the manager has no control over these factors. This is consistent with the concept of responsibility accounting, which suggests that a manager should not be held responsible for costs over which he/she has no control. Because of noncontrollable items, it is possible to have good management performance despite poor performance of the subsidiary, and vise versa. Separating the two would be important in rewarding and retaining good managers. The main purpose of performance evaluation is to motivate managers and other employees to achieve organizational goals. Managers are likely to be more highly motivated if they know that their performance is fairly measured, appreciated, and rewarded. Several issues must be addressed in measuring the profit of a foreign subsidiary for performance evaluation purposes. These include: Whether the effect of corporate transfer pricing policy on costs and revenues should be included or excluded from the measure of proflt. Whether corporate overhead allocations should be included or excluded from the measure of profit. Whether foreign subsidiary profit should be measured in local currency or parent company currency. If parent company currency, whether translation adjustments should be included in profit or not. Whether profit should be based on historical cost accounting or some current value accounting method. During a period of inflation, asset values based on historical costs often understate their current values. Lower asset values result in higher profits through lower depreciation and cost-of-goods-sold expenses. Lower asset values also results in a lower base for calculating rates of return. The combined effect of these two factors is a higher rate of return on assets based on historical costs than if assets were adjusted to their current values. This could distort the evaluation of the performance of foreign subsidiaries, especially when comparisons are made across subsidiaries located in different countries experiencing different levels of inflation. Solutions to Exercises and Problems 1. For capital budgeting purposes, the U.S. company needs to determine the after-tax cash inflow in U.S. dollars arising from the royalty payment. Three factors will affect the net amount received by the U.S. company: (1) German withholding taxes on royalty payments made to a foreign parent company, (2) the exchange rate between the euro and the U.S. dollar, and (3) taxes paid in the U.S. on the royalty received. Assuming the royalty is to be paid annually for a number of years, assumptions must be made regarding the stability of the tax rules in Germany and the U.S. and forecasts must be made regarding the euro/U.S. dollar exchange rate over the investment horizon. 2. In this exercise, students are expected to select a developing country and find the relevant information. Try to use an Internet search engine, such as Google and Yahoo, or any other source. The source(s) used should be clearly acknowledged. Information should be structured under social influence, political influence, economic influence, and technological influence. The purpose of this exercise is to emphasize the importance of being able to think and work independently. Exhibit 5 can be used as guidance for collecting the necessary information with regard to the selected country. Students may not be able to find the relevant information under all the items in Exhibit 5. However, this would be a good learning experience for them. Assessment of an appropriate response to this question should be based on the seriousness of the attempt made. 3. If the exchange rate is expected to remain constant, then the real dollar value of the German mark is expected to decline at the same rate as the real mark value, namely the 5% German inflation rate. Hence, the real dollar value of the depreciation tax write-off will decline at the rate of 5% per annum. If the German tax rate is 50%, then a depreciation charge of $5 million is worth $2.5 million in 2005 dollars. If the real dollar value of this write-off is declining at the rate of 5% annually, then its real value in 2009 (given that the write-off is taken at the end of the year) is: $2,500,000 (.783526) = $1,958,815. (.783526 is the factor used to calculate the present value of an amount received at the end of five years at 5% discount rate) 4. The exchange rate between the Chinese RMB and the U.S. dollar is expected to remain constant therefore all calculations may be done in dollars. The annual cash flow as a consequence of the original investment proposal is: Project cash flow in China: Sales (25,000 units @ $50) less: cost of Chinese material (25,000 units@$15) less: cost of U.S. components (25,000 units@$8) Gross Profit less: depreciation ($750,000/ 5 ) Pre-tax profit less: 40% Chinese tax Net Income add back depreciation Annual project cash flow 1,250,000 -375,000 -200,000 675,000 150,000 525,000 210,000 315,000 150,000 465,000 Project cash flow to Sedona: Cash flow to Sedona is the same as annual project cash flow in China because cash equal to depreciation may be returned freely to the U.S: $465,000 Profit on Sedonas sales of components, (25,000 units x $4 unit x .60 after tax) $60,000 Cash reduction on Sedonas loss of current exports (25,000 units x $15 profit contribution x .60 after tax): $225,000 At the end of 5 years no additional cash will be received in respect of building and equipment as these will have been fully depreciated. (a) Flow in ThousandsYear15% PV factorPV of flowCost of project Project flows Profit on components Lost export profit WC recapture$1,500 465 60 -225 7500 1- 5 1- 5 1- 5 51.000 3.352 3.352 3.352 0.497 (1,500) 1,559 201 (754) 373 -121 NPV is Negative $121,000. Therefore reject. (b) Since current exports will now be lost in any case, the lost profits on current exports are not an incremental flow. Flow in ThousandsYear15% PV factorPV of flowCost of project Project flows Profit on components WC recapture$1,500 465 60 7500 1- 5 1- 5 51.000 3.352 3.352 0.497 (1,500) 1,559 201 373 633 NPV is now positive $633,000. Therefore accept. (c) Cash flow to the U.S. parent would not change, because the drop in Chinese taxes will be offset by an equal increase in U.S. taxes on profit remitted to the U.S. Pre-tax profit (original projection) Less: 20% Chinese taxes Net income dividend to U.S. Dividend received from China Add back Chinese taxes Grossed up taxable U.S. income Tentative 40% U.S. tax charge Less; credit for Chinese tax paid Additional U.S. tax paid Dividend to U.S. after additional taxes Add back depreciation Annual project cash flow to U.S. $525,000 -105,000 420,000 420,000 105,000 525,000 210,000 -105,000 105,000 315,000 150,000 465,000  5. The risk management activities of Nokia Company cover strategic, operational, financial, and hazard risks. Financial risk management (identifying, evaluating and hedging) is one of the two main objectives of the Treasury function. Since a substantial proportion of Nokias production and sales activities are outside Euro zone, managing foreign exchange risk is crucial to the companys success. Foreign exchange exposures are mainly hedged with derivative financial instruments such as forward exchange contracts and foreign exchange options. The majority of financial instruments hedging foreign exchange risk have durations of less than a year. Treasury is responsible for monitoring and managing the interest rate exposure of the Group. Interest rate risk mainly arises through interest bearing liabilities and assets. Credit risks related to customer financing are analyzed, monitored and managed by Customer Finance section. Credit risks are approved and monitored by the Credit Committee in accordance with the principles set out in the Companys credit policy. Financial credit risk, which is the risk of the counterparties to a financial instrument being unable to meet their obligation, is measured and monitored by the Treasury function. Nokias policy is to guarantee a sufficient liquidity at all times by efficient cash management and by investing in liquid interest bearing securities. Insurance is purchased for risks, which cannot be internally managed. 6. It is clear that U.S. companies place much more emphasis on profit oriented goals compared to Japanese companies, which place more emphasis on sales volume and production costs. One reason for this is the pressure from the capital market for companies in the U.S. to achieve profit targets. Unlike U.S. companies, Japanese companies are not under so much pressure to focus on profits, because in Japan the capital market is not the main provider of finance for business; a greater proportion of shares is held by related banks, suppliers, and corporate customers. These stakeholders are more interested in strong long-term business ties than in maximizing short-term profit. Management jobs are relatively more secure in Japan, and there is less pressure for managers to show short-term results. On the other hand, price competition in export markets is very intense among Japanese companies, and this is reflected in their concern for production costs as a top goal. Another reason for the emphasis on profit in the U.S. is cultural. The U.S. is a highly individualistic society, and as a result, demonstration of achievement becomes important. In the case of companies, profit is a clear demonstration of achievement. On the other hand, Japan is a collectivistic society, where long-term survival is highly valued highly, and this is reflected in the focus on sales growth and reducing production costs. 7. There is increasing recognition internationally that focusing on financial measures alone is not sufficient in managing the business, and other factors such as customer satisfaction and internal business processes also should be considered. The balanced scorecard provides a mechanism for incorporating a variety of measures into the performance evaluation process for this purpose. The balanced scorecard is a performance management system that can be used in any organization to align its vision and mission with customer requirements and day-to-day work, monitor implementation of business strategy, build organization capacity, and communicate progress to all employees. 8. The statement is correct in that it is not always possible to clearly separate the performance of a subsidiary from that of its managers, because costs often cannot be classified as either completely controllable or completely uncontrollable and are influenced by both managerial actions and other external factors. External factors that influence a subsidiarys performance include decisions made by corporate management, policy decisions by the parent country and host governments, and other factors such as terrorism, labor strikes, and natural disasters. However, the second part of the statement is not correct. It is necessary to separately identify the performance of the managers from the performance of the subsidiary, because it is neither correct nor fair to include the impact of factors beyond a managers control in evaluating his or her performance. Managers expect to be evaluated on the basis of their own performance focusing on the impact of the decisions they have made. A main objective of performance evaluation is to motivate managers to perform better over time and to reward good performance. This cannot be achieved if managers performance is not separately identified. However, as described above, this is not always an easy task. 9. It would be appropriate to evaluate the performance of a foreign subsidiary in terms of local currency (rather than in terms of parent currency) when the foreign subsidiary is not expected to generate parent currency to be received by the parent. Such a case might exist, for example, when the foreign subsidiary plays the role of a raw material supplier. In evaluating other types of foreign operations, use of the local currency could be justified by the argument that over the long run the ability to achieve good performance in local currency would result in good performance in parent company currency. 10. The complexities in developing global business strategies arise mainly from the diversity in business environments internationally. Economic and legal environments vary across countries and are reflected in differences in the level of economic development, regulatory structures, taxation systems, financial reporting requirements and enforcement mechanisms, and inflation rates. Another element of the business environment that varies internationally is the political situation. Host governments attitudes towards foreign business and the level of political stability in a host country are factors that will have a direct impact on foreign operations. For example, a non-Chinese company seeking to establish a business in China is required to enter into a joint venture partnership with a local entity. This is not true in many other countries. Labor laws also can vary across countries. In some countries, such as Germany and France, where trade unions are strong, it is more difficult for firms to lay-off employees than, for example, it is in the U.S. One of the most important factors that cause complexities in developing global business strategies relates to cultural difference across countries. Both the formulation of strategy and the communication of strategy to subsidiary managers are affected by the cultural value orientation of the host country. Language can be another impediment to developing a global strategy. Certain ideas in the corporate strategy may not be capable of translation into the host country language. 11. This question should be answered by the student stating whether or not they agree with the view expressed, and then developing a discussion in a logical fashion to support the position taken. The main points that could be considered in such a discussion include the following: Globalization is a process that leads to convergence of markets internationally, making national boundaries irrelevant. Globalization is also associated with a particular set of market-based values, such as the use of capital market oriented measures in evaluating performance of businesses. Proponents of globalization argue that the forces of globalization are so strong that every society has to fully embrace it if not to be left behind. For example, as financial markets are becoming increasingly integrated, multinational businesses are evaluated in the same fashion regardless of where they are located. On this view, it is argued that globalization has made cultural differences among countries irrelevant in conducting business. This seems to be the rationale for the efforts to develop a set of global standards for financial reporting. On the other hand, research has shown over and over again that different societies have different cultural value orientations and that these cultural values influence every aspect of life, for example, the behavior patterns as managers, employees and investors. One of the most important objectives of managing a multinational business operation is to motivate its employees to perform better. However, a single strategy cannot be effective in motivating people from different cultural backgrounds, because they tend to respond differently depending on their value orientations. For example, offering financial incentives to employees may be effective in a U.S. company, but not so effective in a Japanese company. There may be nonfinancial but more culturally sensitive incentives, which are more effective in motivating Japanese employees, such as recognition as a valued member of the company. To be successful in business, it is essential to be sensitive to local conditions and circumstances. What we have is a situation where two forces going in opposite directions, the force of globalization in the direction of convergence, and the force of culture emphasizing the importance of local conditions and values. It is not possible to ignore one in favor of the other, because both are important. Therefore, what is needed is a compromise, or to be sensitive to the positive aspects of both forces in developing strategies and standards. CASE 1: CANYON POWER COMPANY Solution Project Perspective (in Indian Rupees)Year 1Year 2Year 3Year 4UnitsPrice (Rs.)Total (Rs.)UnitsPrice (Rs.)Total (Rs.)UnitsPrice (Rs.)Total (Rs.)UnitsPrice (Rs.)Total (Rs.)SalesLocal5,000 4,500.00 22,500,000  6,000  4,950.00 29,700,000  7,000 5,445.00 38,115,000  8,000 5,989.50 47,916,000 Export 10,000  4,500.00 45,000,000  12,000  4,950.00 59,400,000  14,000  5,445.00 76,230,000  16,000  5,989.50 95,832,000 Total sales67,500,000 89,100,000 114,345,000 143,748,000 Operating expenses(40,000,000)(40,000,000)(40,000,000) (40,000,000)Depreciation(17,975,000)(17,975,000)(17,975,000)(17,975,000)Interest expense (27,000,000 x 10%)(2,700,000) (2,700,000)(2,700,000)(2,700,000)Royalty payment(20,000,000)(20,000,000)(20,000,000)(20,000,000)Earnings(13,175,000)8,425,000 33,670,000 63,073,000 add: depreciation17,975,000 17,975,000 17,975,000 17,975,000 Cash flow from operations4,800,000 26,400,000  51,645,000 81,048,000 Salvage value of plant00010,000,000 Repayment of local loan000(27,000,000)Total annual cash flows4,800,000 26,400,000 51,645,000 64,048,000  Net Present Value:Year 1Year 2Year 3Year 4TotalTotal annual cash flows  4,800,000  26,400,000  51,645,000  64,048,000 Present value factor (16%)0.862 0.743 0.641 0.552 Present value 4,137,600  19,615,200  33,104,445 35,354,496  92,211,741 Initial investment(67,500,000)Net Present Value (NPV) 24,711,741 Initial Investment:$Ex. RateRs.Equity1,500,000 45 67,500,000 Calculation of depreciation:$Rs.Cost of plant 1,800,000 4581,000,000 Installation costs 15,000 45675,000 Testing costs5,000 45225,000  1,820,000 81,900,000 Less: Salvage value(10,000,000)Depreciable cost 71,900,000 Annual depreciation expense (71,900,000/4 years) 17,975,000   Parent Company Perspective (in U.S. dollars)Year 1Year 2Year 3Year 4TotalExchange RateRs. 45Rs. 43Rs. 40Rs. 38Royalties (Rs. 20,000,000) $ 444,444  $ 465,116  $ 500,000  $ 526,316 Dividends (Earnings)0 195,930 841,750 1,659,816 U.S. income tax on dividend0 (68,576)(294,613)(580,936)Terminal value (Rs. 10,000,000)0 0 0 263,158 Total cash flow to parent $ 444,444  $ 592,471  $ 1,047,138  $ 1,868,354 Present value factors (16%)0.8620.7430.6410.552Present value $ 383,111  $ 440,206  $ 671,215  $ 1,031,331  $ 2,525,864 Initial investment 1,500,000 Net present value $ 1,025,864  The positive NPV from both the project and parent company perspectives would suggest that the proposal should be accepted. Students should explore other issues to be considered before making a final decision including, for example, conducting a sensitivity analysis. Note: Project perspective the foreign bank loan is not part of the initial investment by the parent Parent company perspective in addition to royalties, dividends and terminal value are cash flows to the parent. CASE 2: LION NATHAN FACES REALITY! Solution Lion Nathan is a typical case of a company, which has grown from its humble beginnings to become a large MNC, one of Australasias largest brewery companies. With a Chairman/CEO who has a passion for the brewing industry, Lion entered into a new phase in its growth with the decision to expand across borders, first to Australia and then to China (Exhibit II). The purpose of this case is to highlight some of the accounting and related issues faced by companies like Lion that enter into foreign markets that are different in many ways from those of their own countries. Students are expected to prepare a report identifying the main strategic issues related to Lions Chinese operation. On the surface at least, the conditions of the Chinese beer market appeared to be excellent as a business proposition. For example, Wuxi, situated in the Yangtse River Delta area, was one of the wealthiest cities in China; the region had very high growth rates over several years; the level of beer consumption, while currently low, was on the increase; Wuxi offered a great opportunity for further expansion within China, the worlds second largest market. Lion invested over $200 million. However, with all the resources and expertise in the industry, the Chinese initiative was fraught with problems from the beginning. Issues As part of the joint venture arrangement, Lion was expected to retain local management personnel, except for specialists in production and marketing. However, this was not easy. The complex nature of the issues related to international mergers and acquisitions: In 1998, Kirin Brewery, Japans largest Brewer, purchased 45% of Lion. In 1999, Lion entered into an agreement with a German Brewer, Brauerei Beck, showing Lions commitment to China. However, there were some concerns about Kirins motives and commitment to China (Exhibit III). Kirins attitude was problematic to Lions strategic direction. Currency translation issues, e.g., the loss of RMB 83.8 million was a 32% improvement compared to the previous year, but in Australian dollar terms, this was only a 21% improvement. How could this be? The importance of market research as part of investment decisions, particularly in foreign markets. Lion does not appear to have conducted a thorough market research before venturing into the Chinese market, which was characterized by, A high level of competition involving the major brewery companies from around the world, Transport problems, Problems of recruiting, training, and retaining local personnel, The differential treatment of foreign companies compared to local companies, for example, in applying regulations. Cultural issues -- The importance of understanding the impact of cultural values on peoples behavior, for example, in conducting business. The way business is conducted in China, e.g., the role of guanxi in business dealings. Long-term vs. short-term orientation (Confucian dynamism). Lions executives may not have fully understood the cultural differences and the impact of those differences on the behavior of business people. The effect of corruption on business activities. To emphasize that certain business practices may be considered as corruption in society, and accepted behavior in another society. The concept of globalization itself would be an interesting issue for discussion. For example, are the critiques of globalization right when they refer to it as a lot of globolony? Other possible topics for discussion include internationalization of capital markets, for example, the reasons for MNCs to list their shares on foreign stock exchanges, and the problems associated with brand valuation, and the impact of brand values on the reported financial position and results. IAS -38 could be incorporated into this discussion.     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