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Unit 1: Financial Management in Global Context

shareholders demand a higher return for the increased risk they are now exposed to. Once again Notes
the MNC is assumed to have an advantage in obtaining funds at a lower cost than the purely
domestic firms. This is due to the larger opportunities and resources available to it.
As shown in the diagram, the firm continues to accept projects as long as the marginal cost of
financing the projects is greater than the marginal returns on projects. A purely domestic firm
accepts projects up to point A while the MNC continues to accept projects up to point B. The
MNC accepts projects up to a higher level due to the cost advantages and opportunities in
foreign countries. In both the cases, the firm accept projects as long as the expected benefits from
additional projects exceeds the marginal cost of the projects. This comparison helps us to
understand why firms expand internationally. However, the analysis may change in cases where
no feasible foreign opportunities for firms are available or when foreign projects are riskier
than domestic firms resulting in a higher cost of capital.

Figure 1.2: Cost-benefit Evaluation for Domestic Firms vs MNCs
Domestic
firm’s cost of capital MNC’s cost
of capital
Return
on
projects
MNC’s investment
opportunity set
domestic firm’s
investment
opportunity set
Appropriate
size for purely Appropriate
domestic firm size for MNC

A B Asset Level of the firm

Self Assessment

Fill in the blanks:
14. There are three primary motivations for firms to pursue international business – to expand
sales, to acquire resources and to diversify …………………… of sales and supplies.

15. Global integration of goods and services improves the overall …………………… of
resources and also tends to increase competition forcing firms to be more efficient.

Case Study Financial Crisis

he current financial crisis is first and foremost a crisis of confidence. The tip of the
iceberg may be the subprime mortgage crisis and its immediate aftermath, but the
Troots of the crisis have to do with unsustainable dual deficits (fiscal and trade) that
have resulted in gargantuan levels of U.S. debt, both private and public. The current
financial crisis happened as things were sold to people who could have never paid it back.
It started with sub-prime crisis, where the greed led to a great divide. One side was greedy
group of people, companies and countries that wanted to make more profit than possible.
Contd...

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