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MGNT3580
Global Enterprise Management
Instructor: Gongming Qian

Section IIII
International Financial Management

PART I International Cash Management

Economic Ordering Quantity Model

Assumptions:
1. Cash used is constant during a certain period of time; and

2. Both cash inflow and outflow from business operations occur in a constant and predictable way.

Notations
C = Cash balance (through selling securities or borrowing); C/2 = Average cash balance; C* = Optimal cash balance; F = Fixed cost involved in selling securities or borrowing; K = Opportunity cost of cash holding; and B = Total cost (required to meet the need of transactions for the whole period of time.

The Cost of Cash Balance
B = Cost related to excess cash holding + Cost related to daily transaction = (Average cash balance ? Opportunity cost) + (Number of transaction ? Transaction cost)

The Cost of Cash Balance

B = (C/2 ? K) + (T/C ? F)

Optimal Cash Balance

dB/dC = K/2 - TF/C = 0

2

Optimal Cash Balance

C = 2TF/K

2

Exercise Questions

Question 1 How can a centralized cash management system be beneficial to the MNE?

Question 2
Assume, on May 1 1999, a U.S.-based MNE had \$1,000,000 in cash available for 30 days. It could earn 1% on a 30-day investment in the US. Alternatively, if it converted the dollars to French franc, it could earn 1.5% on a French deposit. The spot rate of the French franc was \$0.12. The spot rate 30 days from May 1, 1999 was expected to be \$0.10. Should this firm invest its cash in the U.S. or in France. Substantiate your answer.

Solution If the firm invests in a French deposit, it will convert \$1 million to 8,333,333 francs, which will accumulate to 8,458,333 francs after one month (due to the 1.5% interest rate).

Solution
If the spot rate of the francs is \$0.10 after one month, the francs will be converted to \$845,833, which is less than the amount of dollars the firm started with. Thus, the firm should invest its cash in the U.S.

Question 3
The following is a matrix of annual payments among subsidiaries for the Amgen Corporation, designated by the countries of specific subsidiaries.

Question 3 (continued)
In Million US\$

Paying
____________________________________________________________________

Receiving Norway Sweden Demark Finland Total receipt _____________________________________________________________ Norway --10 20 20 50 Sweden Demark 30 30 --40 40 --10 40 80 110

Finland 10 20 30 --60 _____________________________________________________________ Total Payments 70 70 90 70

Question 3 (continued)
What are the total payments in the Amgen system without netting? Under ordinary foreign exchange market conditions, Amgen’s treasury estimates that its transaction costs on foreign exchange are 0.25%. What is Amgen’s financial savings from adopting a payment netting system?

Solution
Summarizing the payments/receipts matrix, we get the following in million US\$:
Total Receipts Total Net Payments Receipt Net Paym

ents

___________________________________________________________________________________

Norway

50

70

---

20

Sweden
Demark

80
110

70
90

10
20

-----

Finland

60

70

---

10

___________________________________________________________________________________

Solution
Without netting, the total volume of payments is \$300 million. Foreign exchange costs in the case without netting are: \$300 million ? 0.0025 equals \$750,000 annually.

Solution
With netting, the volume of foreign exchange transactions falls to \$30 million. Transactions costs associated with this case are \$30 ? 0.0025 equals \$75,000 annually. Thus, the netting system results in an annual saving of \$675,000.