Exam 15: International Corporate Governance and Control

Since the cash flows generated by a foreign target will eventually be converted to the parent's currency, there is no need to consider the foreign exchange rate in the capital budgeting process.

Exhibit 15-1 Klimewsky, Inc., a U.S.-based MNC, has screened several targets. Based on economic and political considerations, only one eligible target remains in Malaysia. Klimewsky would like you to value this target and has provided you with the following information: • Klimewsky expects to keep the target for three years, at which time it expects to sell the firm for 500 million Malaysian ringgit (MYR) aFter deducting any taxes due. • Klimewsky expects a strong Malaysian economy. Consequently, the estimates for revenues for the next year are MYR300 million. Revenues are expected to increase by 9 percent over the following two years. • Cost of goods sold is expected to be 60 percent of revenues. • Selling and administrative expenses are expected to be MYR40 million in each of the next three years. • The Malaysian tax rate on the target's earnings is expected to be 30 percent. • Depreciation expenses are expected to be MYR15 million per year for each of the next three years. • The target will need MYR9 million in cash each year to support existing operations. • The target's current stock price is MYR35 per share. The target has 11 million shares outstanding. • Any cash flows remaining aFter taxes will be remitted by the target to Klimewsky, Inc. Klimewsky uses the prevailing exchange rate of the Malaysian ringgit as the expected exchange rate for the next three years. This exchange rate is currently $.23. • Klimewsky's required rate of return on similar projects is 13 percent. -Refer to Exhibit 15-1. The target's board has indicated that it finds a premium of 30 percent appropriate. You have been asked to negotiate for Klimewsky with the Malaysian target. What is the maximum percentage premium you should be willing to offer?

The valuation of newly privatized businesses is generally more difficult than the valuation of a foreign target that has operated privately for several years.

While acquisitions of privatized businesses may be attractive because of the potential for MNCs to increase their efficiency, the valuation of these businesses is generally more difficult than the valuation of existing businesses.

If potential acquirers are based in different countries, their required rates of return when considering a specific target will only vary if the desired use of the target is different.

An institutional investor such as a public pension fund or mutual fund that invests in the stock of a company and plans to hold the shares for a long time is likely to be a shareholder activist.

An MNC valuing a foreign target for acquisition purposes must account for all of the following, except:

Privatization involves the sale of previously government-owned businesses by the government.

Acquirers may have different required rates of return because of differences in the local risk-free interest rate.

Because of errors in cash flow or exchange rate estimates, the estimated net present value of acquiring a foreign target could be underestimated.

The initial outlay for a project in a foreign country may decline if property values in that country decline.

The valuation of a proposed international divestiture can be determined by comparing the present value of the cash flows if the project is continued to the proceeds that would be received (aFter taxes) if the project is divested.

An international acquisition may be preferable to the establishment of a new subsidiary because the firm can immediately expand its international business and benefit from existing customer relationships.

A foreign target's expected future cash flows generally vary among different MNCs valuing the target.

Premiums required to entice a target's board of directors to approve an acquisition are usually between 1 and 3 percent of the target's market price.

Downsizing reduces expenses but may also reduce productivity and revenue.

It is always the best course of action to divest a foreign project if the expected cash flows from the project decline substantially.

When an MNC assesses targets among countries, it would prefer a country where the growth potential for its industry is ____ and the competition within the industry is ____.

If a target is privately held, general stock market conditions will not affect the amount that an acquirer has to pay for a foreign target.

The Sarbanes-Oxley Act requires executives and the board of directors to conduct a thorough review when assessing acquisitions.