SMU MBA ASSIGNMENTS

1. Supplying Products to Foreign Buyers : Foreign production is not always an answer. Foreign markets can be better served by exporting, rather than by creating a foreign subsidiary if there are economies of scale. If large scale production reduces unit cost, it is better to concentrate production in one place.  MES is the minimum rate of output at which Average Cost (AC) is minimized. If minimum efficient scale (MES) is not achieved, then export.

In other words, if there is excess capacity, why not utilize that and export outputs to other countries? There is no point in creating another plant overseas when domestic capacity is not fully utilized. If the foreign demand exceeds the minimum efficient scale, then FDI.

Figure -2 : Minimum efficient scale and FDI.

1. International Joint Ventures: JV is a business organization established by two or more companies that combines their skills and assets.

• A JV is formed by two businesses that conduct business in a third country. (US firm + British firm jointly operate in the Middle East)
• Joint venture with a local firm (GM + Shanghai Automobile Company)
• Joint venture may include local government (Bechtel Company-US; Messerschmitt — Boelkow — Blom, Germany; Iran Oil Investment Company; National Iranian Oil Company)

International JV has certain benefits. These are

• Large capital costs — costs are too large for a single company
• Protection — LDC governments close their borders to foreign companies
• Bypass protectionism. e.g.: US workers assemble Japanese parts. The finished goods are sold to the US consumers.
• The new venture increases production, lowers price to consumers.
• The new business is able to enter the market that neither parent could have entered singly.
• Cost reductions (otherwise, no joint ventures will be formed)
• increased market power

1. Tax Policy towards MNCs: Operating in many countries, MNCs are subject to multiple tax jurisdictions, i.e., they must pay taxes to several countries. National tax systems are exceedingly complex and differ between countries.  Differences among national income tax systems affect the decisions of managers of MNCs, regarding the location of subsidiaries, financing, and the transfer prices (the prices of products and assets transferred between various units of MNCs).

Multiple Tax Jurisdictions creates two problems, overlapping and under lapping jurisdictions. When overlapping occurs, two or more governments claim tax jurisdictions over the same income of an MNC. The overlapping may result in double taxation.

Conversely, when under lapping occurs, an MNC falls between tax jurisdictions and escape taxation. Under lapping encourages tax avoidance.  National governments may choose a territorial jurisdiction or national tax jurisdiction or both.

1. Transfer Pricing : MNCs try to reduce their overall tax burden. An MNC reports most of its profits in a low — tax country, even though the actual profits are earned in a high tax country.

t_p = tax rate in the parent country ; t_h = tax rate in the host country

If t_p > t_h, then under price its exports to the subsidiary in the host country, and overprice its imports from the subsidiary in order to lower tax.

Purpose is to manipulate prices between headquarter and the subsidiaries so that profits are highest in the low tax country.

Thus, a multinational company’s overall tax could be paid at the minimum of all tax rates of the countries in which it operates.

1. Taxation and Gains from Factor Mobility : It is seen that US firms invest overseas because the returns are higher there. Assume both countries have the same corporate tax rates = 40%

US               Canada

Pretax profits                   10%            12%

Tax                                    4%              4.8%

Net to investors               6%              7.2%

Total Gains from domestic investment = 10% (= 4% + 6%) because tax revenues can be used for public purposes.

Total Gains from foreign investment = 7.2% (because US government gets nothing). The tax revenue which could have been used to build US highways would be used by Canadian government to build their highways.

A firm has to evaluate all such kinds of complex factors to fix up any strategy before choosing to enter a foreign market