Analyse the prospects and the problems for a Multi National Enterprise who proposes to make a Foreign Direct Investment
AC308 International/Multinational Management and Accounting
Part A
Briefing
This report will analyse the prospects and the problems for a Multi National Enterprise who proposes to make a Foreign Direct Investment, therefore many factors will need to be considered by the MNE, as this is arguably one of the most important decisions that faces a multinational company (Demirag and Goddard 1994). This is namely because of the large capital outlay over a duration of time, a decision once made that cannot be easily reversed.
Company Background
British American Tobacco is a large Multi National Enterprise established in 1902 by consolidating two companies American Tobacco co. and the Imperial Tobacco of the UK this was hoped to end an intense trade war, 'Under the agreement, the two companies will not trade in each other's domestic markets and acquire the right to use each other's brands and trade marks in their own territory. Imperial Tobacco's and American Tobacco's businesses outside the 'home' markets of the UK and US are transferred to British American Tobacco'. Then in 1911 the American tobacco Co divest its shares and the company becomes listed on the London Stock Exchange.
Country Background
Country of choice is the northern African country of Libya which for some time has been sanctioned by both the US and the UN, its tobacco industry is state owned, however articles in the October 2003 country report have made suggestions that this will soon become privatised. BAT would obviously like to monopolise on the situation this is because the sanctions imposed in Europe are being lifted ahead of those from the US, the theory behind getting in there first is highlighted by (Shapiro 1989) ' The essence of corporate strategy is creating and then taking advantage of imperfections in the product and factors markets'.
Libya is a country that has in the past two decades been crippled by trade sanctions for its national's roles in various activities such as the Pan Am bombing over Lockerbie. These have meant that it's main source of income the export of crude oil and natural gasses. The country has a GDP $45.4 Billion (purchasing Power Parity 2000 est.)
Source: CIA the world fact book 2001 its industry break down is mainly manufacturing and service due to the bad climatic conditions and poor soils, with 55% of incomes from manufacturing. With the sanctions in place the oil and petrochemicals have been traded with Italy, Germany, Spain, France, Turkey, Greece, and Egypt. Libya is in great need of FDI's with its main source of income becoming devalued due to the oil reserves of Iraq being place onto the market (see appendix 1). The country is in need of these FDI to buoy its flagging economy. With Col. Muammar Abu Minyar al-QADHAFI and the government are introducing reforms that will catalyse the process and whose core objective is privatisation and to adapt itself more gearing towards strengthening its global economic relationships, a stronger acceptance will in turn lead to more investment
The Economic Activity
The tobacco industry factors three main segments the raw material, leaf growing, manufacturing, and the distribution and sales, I will be focusing on the manufacturing process, and will report on the advantages of transportation and the economies of scale.
A contributing factor to any MNE hoping to make a FDI is the market control and getting there first is best with the UN sanctions lifted ahead of American one's it allows for working relationships and loyalty to be build.
The economic advantages are a great pull factor according to with good economic ...
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The Economic Activity
The tobacco industry factors three main segments the raw material, leaf growing, manufacturing, and the distribution and sales, I will be focusing on the manufacturing process, and will report on the advantages of transportation and the economies of scale.
A contributing factor to any MNE hoping to make a FDI is the market control and getting there first is best with the UN sanctions lifted ahead of American one's it allows for working relationships and loyalty to be build.
The economic advantages are a great pull factor according to with good economic growth of GDP at 6.5% est. for 2000, current high unemployment will mean that there is a willing work force with a 30% unemployment rate, with most MNE paying more that the state operated industries. The currency exchange rate is the most important financial factor having been a multi tiered system whereby one its one for government organisations and foreign companies and one for the people but this has been abolished and with the devaluation of the Dinar for foreign trade on 1 January 2002 to 21.30 Dinar per US dollar; the previous official rate was 0.63 Dinar per US dollar (Dec 2001).
Barriers to Entry: -
There are various factors as to why a company may not want to make a FDI or possibly why a company cannot make investment, these are known as the barriers to entry, barriers to entry can come from various aspects competition represents one of the legal barriers the other being economic barriers. The case brought against WorldCom-Sprint, the FTC charged that the merger would have increased concentration in long-distance telecommunications and created "barriers to entry" that would have excluded competitors (D.T.Armentano Barriers to entry April 2004).
Competition
However in the case of BAT and Libya there is only currently competition from the state owned tobacco producer which are from certain indicators to be privatised by the president Col. Quadahafi and his government which therefore leads us to the second barrier which is the economic barriers to entry which are a whole other matter entirely these reflect the company and how diverse it is to change, these barriers are in reality consumer benefits that dominant firms can provide but smaller competitors may have trouble meeting or beating, these were the points raised by the competitors of both WorldCom and Microsoft cases and they were in strong agreement of the governments antitrust initiatives.
However as discussed previously there is no competition in existence and with the US sanctions American companies are not yet able to trade with Libya, a barrier as there is no competition, Libya's inability to publish fiscal data, there is very little accessible or comparable data. This inconsistency and lack of information in the business world is perceived as risky and would lead to unwillingness to invest,
Economic
A general barrier to entry is often the stability of the country of choices economic and currency stability in regards to the currency with the gold reserves revaluation, which took place in December 1971; Libya retained its existing parity with gold. As a consequence, the dollar value of the Dinar rose from US$2.80 to US$3.04, where it was kept until 1974 when it moved to LD1 equal to US$3.3778. The Dinar was maintained at this rate until March 1986 floating rate linked to the SDR. This move resulted in a 10-percent decline in the value of the Dinar, but has served to make it stable even though it has devalued it will in the long term draw foreign investment and therefore improve the financial, and global situation of the country. Other barrier's will be posed as the world has an educated awareness of the health risk associated with smoking and these may result in specific tax regulations put in place on cigarettes.
Political Risk
The importance of political risk needs to be considered but despite the extreme consequences very little time or money is invested in the research that this area deserves, many authors have written on this matter on both sides of the Atlantic, Rummel and Heenan(1978) they suggest that ad hoc methods are still employed, as Kobrin stated in 1979 it is known that this risk exists but analysis of this is superficial and subjective therefore it is not incorporated in any of the decision making apparatus. But looking at the recent turn of events since September 11th and the Iraq war, it proves just how crucial this should be in the decision making process. Before political risk can be quantified it must be defined Shubik (1983) differentiates between political risk and uncertainty, the paper by Rummel and Heenan (1978). In the case with Libya their main political risk is that they re not ready for global competition and that there are a lack of legal structures in place to host competition (lack of contact with the rest of the economic society for so long has lead to this), the only hindrance that this, may cause is that the government may impose regulatory restrictions until local firms have caught up as mentioned earlier the two types of barriers the economic one that relates to competition may be exercised here.
One cannot rule out terrorism in a political risk analysis as in Spain when Etta did bombings because they were against some of the government decisions hoping to scare of the tourist trade and also evident in Egypt. Bat was in Burma when the terrorist attacks took place on Ms Suu Kyi, and home political pressures forced BAT to withdraw from Burma, BAT Head of investing and corp. strategy stated "Tobacco companies have enough reputation problems hanging round their necks without adding other. Reducing this reputation risk will make a positive contribution to shareholder value" if that were to happen in Libya then Bat may need to pull out again, with so much time and money invested that is not an easy decision to make for a CEO.
Although it may be beneficial to move manufacturing to Libya due to close proximity to Kenya where BAT have leaf plantations, Libya's own infrastructure is poor, it has no rail service, a very poor telecommunications networks, but being modernised with the introductions of a cellular telephone system in 1996 and only 500,000 main telephones in operation that's less than 10%, these facts are from the CIA World Fact book. However as any developing country these are due to be advanced with the rail network plans including a linking network between Tunisia, Egypt and sub-Saharan Africa.
When a company plans to make an investment of any kind it will calculate from some data how much their cost of capital will be they will compare the possible returns with those of if they put it into a risk free investment the method used is called Capital Asset Pricing Model (CAPM). This must be calculated to establish the cost of capital normally defined as the minimum risk adjusted rate of return before an investment decision can be made it is going to form part of the companies general investment portfolio as different assets are financed by different means and have differing returns this is why the Weighted Average Cost of Capital is worked out instead or as well as CAPM. (See Appendix 2 for CAPM). After the CAPM has been calculated then the NPV can be calculated ad in appendix 3 and an investment decision can be concluded bearing in mind all the qualitative factors not jus the results of the figures.
Conclusion
In conclusion I would as management of the BAT Company take on the investment as the advantages specified would outweigh the potential political and financial risks that are present and also the possible barriers to entry.
Part B
Since the news coverage of what is referred to as the Enron Scandal which lead to the demise of the company much emphasis has been put onto the way that accounts are presented in regards to creative accounting there has since been much call for a harmonisation of the accounting standards so that international accounts can be compatible with each other. The reason why the accounting reports must be clear simple and in compliance is very simple.
Shareholders who have invested their time and money into the company, have appointed the principles who are the management to run the company.A problem will arise if there is not clear communication between the owners and the people who run the company. After the 'scandal' with Enron it is very important for these investors and possible future investors to have trust in the companies that they invest in, therefore to rebuild the trust is a big issue, and the lack of trust in the accounting profession, will render it obsolete. Many companies have taken steps to rebuild confidence by making active efforts to be in compliance with the various standards set out, and if there was a harmonisation between the likes of the UK GAAP the US GAAP, if this were accomplished then it would increase investor confidence.
The needs for this are even simpler as the information is made for a wide range of people, and as we can see if a company has subsidiaries the information of a multinational may be assed by a person outside of that country as part of the growing multinational environment. If these rules and regulations could be harmonised throughout the world it would increase reliability, comparability, and increase the soundness of auditing
Also preparing internal information for the appraisal of performance of subsidiaries in different countries would be much easier. Investment appraisal, performance evaluation, and other decision-making techniques of management accounting would greatly benefit from harmonisation. A good example of the need for harmonisation comes about in the inventory valuation, in three main trading countries Japan, UK and US different methods are used, and these differences can have a large effect on earnings or shareholders equity making the accounts from different countries little use when comparing their position in order to make an investment decision. Finally if all of this takes place then the cost of capital should fall due to the reduced risk to investors.
Appendix 1
2002
2003
2004
2005
Oil Exports (US$bn)
0.7
2.9
9.3
9.6
Consumer price Inflation (av)
.1
.7
.9
2.7
Appendix 2
CAPM, Ri =Rf +ß(Rm - Rf)
Ri is the CAPM (expected return, Cost of capital)
Rf is the risk-free rate of return (12%)
Rm is the expected return on market portfolio (18%)
And ß is the Beta (the systematic risk) (0.5)
2% + 0.5(18% - 12%) = 15%
Appendix 3
0-year investment with a Cost of Capital of 15% (as established by the CAPM (it is fairly high due to the lack of financial information in Libya) and the flowing cash flows:
NPV calculation
Year
Cash flow
Present value factor (15%)
Present Value
0
(225,000,000)
0
(225,000,000)
25,000,000
0.87
21,750,000
2
30,000,000
0.756
22,680,000
3-10
60,000,000
(5.02 - 1.63) 3.39
203,400,000
Net Present Value
27,170,000
Bibliography
I. Demirag and S.Goddard Financial Management for International Management, (1994) McGraw-Hill Book Co.
Directory of Multinationals, (2001) 6th edition, Caritas Data Ltd,
Economist Intelligence Unit, (July 2003) 'Country Report, Libya'
Economist Intelligence Unit, (July 2002) 'Country Report, Libya'
Nobes C. and R Parker. (2000) 'Comparative international accounting' 6th edition,
Shapiro A., (2003) 'Multinational Financial Management' 7th edition,
World Tobacco Directory, (2003/2004) 51st edition,
Financial Time, Friday November 7th 2003
http:// htmlwww.nationmaster.com/country/ly/Economy&b_define=1&b_define=
http://www.cia.gov/cia/publications/factbook/geos/ly.
http://www.transparency.org/pressreleases_archive/2003/2003.01.15.gcr_pressconf_london.html
http://www.duke-energy.com/news/mediainfo/viewpoint/020318RP.asp
http://www.bat.com
http://www.fao.org/docrep/X5648E/x5648e0k.htm
