Briefly describe a company’s risk exposure if it invests in an international project.

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Briefly describe a company’s risk exposure if it invests in an international project.

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With the growth in demand for exotic foods, Possum Inc.’s CEO Michael Munger is considering expanding the geographic footprint of its line of dried and smoked low-fat opossum, ostrich, and venison jerky snack packs. Historically, jerky products have performed well in the southern United States, but there are indications of a growing demand for these unusual delicacies in Europe. Munger recognizes that the expansion carries some
risk. Europeans may not be as accepting of opossum jerky as initial research suggests, so the expansion will proceed in steps. The first step will be to set up sales subsidiaries in France and Sweden (the two countries with the highest indicated demand), and the second is to set up a production plant in France with the ultimate goal of product distribution throughout Europe.
 
Possum Inc.’s CFO, Kevin Uram, although enthusiastic about the plan, is nonetheless concerned about how an international expansion and the additional risk that entails will affect the firm’s financial management process. He has asked you, the firm’s most recently hired financial analyst, to develop a 1-hour tutorial package that explains the basics of multinational financial management. The tutorial will be presented at the next board of directors meeting. To get you started, Uram has supplied you with the following list of questions:
l. Briefly describe a company’s risk exposure if it invests in an international project.

Explanation & AnswerSolution by a verified expert

Sample Response

The business risks of a multinational corporation, when it works in a foreign nation, may increase or even decrease. If the market conditions in foreign country are stable or it has a favourable legal system, or the foreign company offers less competition, then there is not much increase in the business risks. The risks may be higher depending upon many factors.
 

Exchange rate risk: The revenues earned in the foreign countries may not be of the same value every time, when they are converted into domestic currency. This is because of the fluctuating exchange rate. Moreover, this inconsistency in exchange rate leads to difficulty in assessing the true value of the income, which is to be received from abroad. For short term foreign contracts, exchange risk can be minimised by indulging in forward contracts, but the long term investments still have to face the exchange rate risk. Thus, while evaluating the risk of foreign investments, exchange rate risk should also be considered along with the cost of capital.
Political risk: Exposure to political risk depends on the political relations between the domestic country and the host country. Host companies may impose certain restrictions on their foreign transactions which will ultimately affect the assets, investments, or the cash flows of the domestic company. When the host company limits the amount of foreign currency transactions, limited cash flows can be remitted to the subsidiaries in the home country from the host country. Such restrictions are known as "Repatriation restrictions''. Companies may also face "Expropriation risks". Expropriation risks arise when the host country seizes the assets of the subsidiaries in foreign company. Apart from these, the host country also regulates the market prices of the products of the subsidiaries of foreign companies. It may also follow corrupt practises and expect bribes.
Taxation Risk: The host government may levy heavy corporate taxes. Thus, the repartied cash flows get affected due to this. Moreover, the host country can also levy heavy duty on parent company's exports which affects the final price and ultimately the demand for the product in the foreign market.

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