Page 239 - DMGT549_INTERNATIONAL_FINANCIAL_MANAGEMENT

International Financial Management

Notes The evaluation process of foreign investments is generally longer, more costly, less accurate
and involves more political and foreign exchange risks. Businesses and governments are
motivated to engage in FDI to (1) expand markets by selling abroad; and (2) acquire foreign
resources (e.g., raw materials, knowledge, production efficiency, etc.). In addition, governments
may also be motivated to gain political advantage.
The IMF defines foreign investment as FDI when the investor holds 10% or more of the equity
of an enterprise. Foreign investment has been a major factor in stimulating economic growth
and development in recent times. The contribution that multinational corporations can make as
agents of growth, structural change and international integration has made FDI a coveted tool of
economic development.

Did u know? Foreign Direct Investment (FDI) is one of the most important sources of
capital. FDI links the host economy with the global markets and fosters economic growth.

14.3.1 Why do Firms Invest Abroad?

MNCs wanting to maximise shareholders’ wealth generally try and increase their foreign business
to become more internationalised. Some of the important reasons why firms decide to invest
abroad are:
1. New Sources of Demand: In many situations growth is limited in the home country. This
may either be due to intense competition or saturation in the share of the market. Thus, an
alternative solution is to penetrate foreign markets where a potential demand exists.
2. Existence of Various Market Imperfections: Various empirical theories, such as that by
Kindlerberger (1969) and Hymer (1975), have emphasized various market imperfections,
that is imperfections in product, factor and capital markets as the key motivating forces
drawing FDI.
Countries differ with respect to resources available for the production of goods. However,
if all resources could be easily transferred among countries, the volume of international
business would be limited. If markets were perfect, all factors of production (except land)
would be mobile and freely transferable. In the real world, markets are imperfect and
factors of production are somewhat immobile. Thus, it is worthwhile for MNCs to survey
markets to determine whether they can benefit from cheaper costs by producing in those
markets. For example, Japanese companies are using Mexico and other low labour cost
countries for production. Many organisations have also established subsidiaries in countries
where production costs are low such as Mexico, Malaysia, Hong Kong and Taiwan.

Foreign direct investment is specially high in Mexico due to the following reasons:
Production costs in Mexican plants are low;

Encouragement provided by the Mexican government to FDI under specific
conditions; and
Mexican peso has been weak, allowing foreign firms to establish a plant at a low
cost.
3. Economies of scale: MNCs may want to enter new markets to increase their earnings and
to realise the full benefits of economics of scale. Companies in industries where the fixed
costs are relatively large need to engage in volume selling to break even and these high
volumes can only be realised if firms expand overseas.

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