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URN:ISBN 951-683-725-5 <URL:http://lipas.uwasa.fi/~ts/icms/icms.html> |
CONTENTS
1
Introduction
1.1 The Problem of International Capital Market
Segmentation
1.2 Review of Relevant Research on Capital
Budgeting Modelling in the Uninational Firm
1.3 Review of Relevant Decision Models for the
Multinational Firm
2
Exposition of the Model
2.1 General Features
2.2 Decision Variables
2.3 Objective Function
2.4 Operating Constraints
2.5 Financial Constraints
Appendix: A List of Indices and Parameters of the Model
References
Footnotes
Please use the following reference to this publication: Jääskeläinen, V., Salmi, T. and Wasiljeff, Y. (1976/1996), "International Capital Market Segmentation in the Face of Joint Operating and Capital Budgeting Decisions of Multinational Firms [online]", available from World Wide Web: <URL:http://www.uwasa.fi/~ts/icms/icms.html>. ISBN 951-683-725-5.
*Helsinki School of Economics, Finland
**University of Vaasa, Finland
A recent (in 1976) development of international financial theory is the application of mathematical programming models to the capital budgeting decisions of the multinational firm. This application is an extension of the capital budgeting theory developed by Weingartner [26] for the uninational firm. The investment and financing decision models for the multinational firm developed so far treat, however, the on-going operations (production, intersubsidiary trade, and sales to customers) as given. This simplification ignores the fact that the on-going operations are interrelated with the capital budgeting decisions of the multinational firm. Suboptimal decisions may thus be indicated. This paper presents a deterministic linear programming model for the simultaneous investment, operating, and financial decisions in the multinational firm, explicitly taking the interactions between the decisions into account.
The model is then applied to hypothetical examples in order to explore whether barriers to capital flows could effectually separate the international capital market into distinct national segments for the multinational firms as they evidently do for the uninational firms. The results support the view that effective segmentation does not result. This is because the multinational firm can bypass the restrictions by utilizing intersubsidiary trade. Partial segmentation occurs, however, when imperfections exist as barriers to capital transfers between the subsidiaries in different countries. This is reflected in the model as a decrease in the value of the multinational firm's objective function as compared to the case with no restrictions on the intersubsidiary capital transfers.
Veikko Jääskeläinen & Timo Salmi & Yrjö Wasiljeff (1976/1996), International Capital Market Segmentation in the Face of Joint Operating and Capital Budgeting Decisions of Multinational Firms, published on the World Wide Web as http://www.uwasa.fi/~ts/icms/icms.html at the University of Vaasa, Finland.
KEYWORDS: capital markets, multinational firms, market segmentation, quantitative budgeting, linear programming
The findings of Agmon [2] and Solnik [22] (concerning the equity markets) indicate that one cannot reject the one market hypothesis on the basis of the present empirical evidence. The findings of Lessard [10] imply that the international capital market can be considered only partially segmented. He presents empirical evidence to show that "the international structure of equity returns can be characterized by a world element and a set of country elements ...".
In support of this empirical evidence it can be argued that barriers to capital flows do not effectively segment the international capital market in the presence of multinational firms. Robbins and Stobaugh [17, Ch. 5] propound that the physical and monetary flows which necessarily occur between the subsidiaries of the multinational firms provide an efficient means for circumventing the restrictions on capital flows._1/
Our paper extends the linear programming approach to simultaneous optimal investment, operating, and financial decisions in the multinational firm. Furthermore, the model to be developed is utilized in order to explore the relevance of capital market segmentation in the presence of the multinational firm. This is done by observing the behavior of a hypothetical multinational firm under varying assumptions about the restrictions on physical and financial flows between the firm's subsidiaries in two different countries. Figure 1 delineates the essence of the four different situations to be explored._2/
F i g u r e 1
# #
$$$ # LLL $$$ # LLL
: # : : # :
: # : : # :
v # v v # v
+---+ # +---+ +---+ # +---+
MM {... | | # | | ...} MM MM {... | | # | | ...} MM
MM ---} | | # | | {--- MM MM ---} | | {---} | | {--- MM
+---+ # +---+ +---+ # +---+
: # : : # :
v # v v # v
# #
[_] # [_] [_] # [_]
# #
Case 1 Case 2
complete segmentation intersubsidiary capital
transfers allowed
# #
$$$ # LLL $$$ # LLL
: # : : # :
: # : : # :
v # v v # v
+---+ # +---+ +---+ # +---+
MM {... | | {...} | | ...} MM MM {... | | {...} | | ...} MM
MM ---} | | {---} | | {--- MM MM ---} | | # | | {--- MM
+---+ # +---+ +---+ # +---+
: # : : # :
v # v v # v
# #
[_] # [_] [_] # [_]
# #
Case 3 Case 4
intersubsidiary trade with barriers to capital transfers
capital transfers allowed
---} financial flow allowed ...} physical flow allowed
+-+
| | affiliate [_] investment
+-+
$$$ local loan market MM
LLL local loan market MM local sales
# barrier
Velasco's duality analysis reveals that each subsidiary has its own unique cost of capital, although the costs are interdependent._6/ The same result is indicated by [21, pp. 288-289] and [20, pp. 85-88]. This result, together with the results referred to in Section 1.1, implies that the effectively segregated international capital market concept cannot be advocated. On the other hand, we cannot apply a single pool of capital approach to the financing decision of the multinational firm, either.
Joint operating and financial decisions of the multinational firm were presented by Salmi [18] in 1972 in the framework of a deterministic linear programming formulation, and independently by Mehta and Inselbag [12] in 1973. Decisions on investments in additional capacity and transfer pricing are included in the former work, but not in the latter. On the other hand, the handling of inventories is excluded from the former.
It is our purpose to present a deterministic one-period linear programming model for the multinational firm for simultaneous decisions on investments in increasing the existing capacity as well as in new acquisitions. Production, sales to outside customers, interaffiliate trade, and interaffiliate as well as outside borrowing sources are simultaneously considered. This is achieved by combining the relevant features of the models developed by Arya [3], Jääskeläinen [8], and Mehta and Inselbag [12]. The extension of our one-period model into a multiperiod case is technically straightforward. However, in practice there is always the problem of the dimensionality of the multiperiod models, which tends to make them unwieldy.
x(ik) = the number of units of product i to be sold to customers
by affiliate k.
y(ik) = the number of units of product i produced by affiliate k.
y(ikh) = the number of units of product i exported from affiliate
k to affiliate h (and thus imported by the latter from
the former).
z(k) = the accepted fraction of the investment in capacity
increase in affiliate k. z(k) E [0, 1].
w(jk) = the accepted fraction of affiliate k's j:th investment
option. w(jk) E [0, 1].
d(k) = borrowing by affiliate k from the local money market in
the local currency.
e(k) = lending by affiliate k to the local money market in the
local currency. (This decision variable also serves as
the closing cash balance.)
m(kh) = the interaffiliate loan granted by affiliate k to
affiliate h. The loan is denominated in the currency of
the host country of the granting affiliate k.
The model treats the interaffiliate transfer prices as
predetermined, although in actual practice they constitute an
additional set of decision variables for the multinational firm. It
would be easy to include this feature in the present model along the
lines developed by Salmi [18] and [20, Sec. 3.2.5, 3.3.2]._11/ The
choice between short-term and long-term borrowing as presented by
Arya [3] is omitted, too.
translation
coefficient sales revenue
K I
max sum tr(k)[1-t(k)] { sum p(ik)x(ik)
k=1 after-tax i=1
coeffic.
production cost export revenue
I I K
- sum c(ik)y(ik) + sum sum p(ikh)y(ikh)
i=1 i=1 h=1
h!=k
i m p o r t s c o s t s transfer
I K price
- sum sum [ut(ihk) + (1 + uc(ik))v(hk)p(ihk)] y(ihk)
i=1 h=1 transpor- duty currency
h!=k tation conversion
interest on interest on inter-
local borrowing affiliate lending
K
- rd(k)d(k) + sum rm(kh)m(kh)
h=1
h!=k
costs on inter- interest on
affiliate borrowing local lending
K
- sum v(hk) [rm(hk) + sm(hk)] m(hk) + re(k)e(k)
h=1 interest stamp-duty
h!=k
annuity of capacity net annuities from
increase investment cost investment options
J(k)
- rg(k)g(k)z(k) + sum [s(jk)-rf(jk)f(jk)] w(jk)
j=1
fixed and pre-
determined costs
- U(k) }
The detailed discussion of the model will be confined to selected
items, because of the limited space. A host of the assumptions made
have to be interpreted directly from the mathematical presentation
of the model with the help of the lists of the variables and the
constants.The procedure for calculating the after-tax yields of the affiliates by a multiplication with the coefficient (1-t(k)) is oversimplified. A proper general procedure for handling the income taxes is discussed in [20, Sec. 3.2.8 and 3.2.9]. Subtracting the production cost instead of the cost of the items sold is also an oversimplification. A better matching procedure can be found in [12].
Technically our model includes only a single one-year fixed and predetermined costs period. The actual planning horizon must, however, cover a much longer time-period, because assuming one-year investments only would be meaningless. Therefore the following method is adopted. All the revenues and expenses of each option are replaced by equivalent net annuities over the predicted economic life-span of the investment option. The net annuities are then used as figures of merit in the objective function.
To be more specific about this method, let the life span of the investment w(jk) be n(jk) years. Assume that a relevant subjective (absolute) rate of interest q(k) can be agreed on._12/ With some trivial arithmetic it is easy to see that the coefficient needed in order to get the annuity required is given by
n(jk)
q(k)[1+q(k)]
rf(jk) = ------------------
n(jk)
[1+q(k)] - 1
For the investments in capacity increase z(k) we need apply the
method for the initial cost only, because the other relevant factors
are reflected by other terms of the objective function. Thus the
pertinent cost for such an investment is rg(k)g(k)z(k), where rg(k)
is defined analogously to rf(jk), g(k) is the total expenditure for
the investment in the capacity increase, and z(k) represents the
fraction of the capacity increase. Had we omitted the coefficient
rg(k), the current period would have been excessively burdened with
the entire expenditure of acquiring the additional capacity, which
would lead to being overcautious about capacity increases. Thus, by
adopting the method discussed above, we have accounted for the fact
that the additional capacity usually is available for more than one
year. When the process described is followed, using a one-period
model is not as strong a simplification as it might seem at the
first sight.
Sales Constraints
sales sales potential
x(ik) .le. X(ik) i = 1,..., I
k = 1,..., K
Inventory Balance Equations
production imports sales exports
K K
y(ik) + sum y(ihk) - x(ik) - sum y(ikh)
h=1 h=1
h!=k h!=k
required initial
closing inventory inventory
= He(ik) - Hb(ik) i = 1,...,I
k = 1,...,K
Storage cost is excluded, because in our one-period approach it is
not essential.Capacity Constraints
capacity capacity initial
usage increase capacity
I
sum a(ik)y(ik) - b(k)z(k) .le. Y(k) k = 1,...,K
i=1
Only one dimension of capacity is assumed in the above. Extension
into a more general case is trivial: only an additional index is
needed.Investment in Capacity Increase
z(k) .le. 1 k = 1,...,Kz(k) means the accepted fraction of the additional capacity (b(k)) that can be acquired in affiliate k. The relevance of a fractional solution depends, naturally, on the nature of the pertinent production process. If, say, paper-making machines constituted the relevant capacity, fractional solutions should be treated as preliminary approximations only. Had we defined the z(k):s as binary variables, a mixed binary linear programming model would have resulted. Furthermore, integer values beyond one might also be relevant for various cases.
Other Investment Options
w(jk) .le. 1 j = 1,....,J(k) k = 1,...,K
Cash Balance Equations
The cash balance equations see to it for each affiliate that cash outflows cannot exceed the cash inflows. They are denominated in the pertinent local currencies.
sales revenue exports revenue
I I K
sum pp(ik)x(ik) + sum sum pp(ikh)y(ikh)
i=1 i=1 h=1
h!=k
local borrowing interaffiliate borrowing
less interest less interest and stamp-duty
K
+ [1 -rd(k)]d(k) + sum [1 - rm(hk) - s(hk)] m(hk)
h=1
h!=k
interaffiliate lending production
less interest expenditure
K I
- sum [1 - rm(kh)] m(kh) - sum cp(ik)y(ik)
h=1 i=1
h!=k
i m p o r t s e x p e n d i t u r e s
I K
- sum sum { ut(ihk) + [pp(ihk) + uc(ik)p(ihk)] v(hk) } y(ihk)
i=1 h=1 transpor- transfer duty currency
h!=k tation price conversion
capacity increase
investment expenditure
J(k)
- g(k)z(k) - sum [ f(jk) - s(jk) ] w(jk)
j=1 expenditure annual
earnings
closing fixed and predeter- initial
cash mined expenditures cash
- e(k) = Up(k) - Eb(k) k = 1,...,K
In the cash flows we do not compute annuities for the investments,
as we did in the objective function.Minimum Cash Balance Constraints
closing required minimum cash closing cash e(k) .le. Ee(k)Local Borrowing Constraints
local maximum local borrowing borrowing potential d(k) .le. D(k)Interaffiliate Loan Granting Constraints
For management policy reasons a maximum acceptable level of interaffiliate loans granted by an affiliate can be imposed by the management. In our numerical examples these constraints are redundant.
interaffiliate maximum level
lending acceptable
K
sum m(kh) .le. M(k) k = 1,...,K
h=1
h!=k
This concludes the presentation of the model developed.
E x h i b i t 1 Solutions
Case 1 Case 2 Case 3 Case 4
Objective
function $ 1311 1338 1480 1430
Variable
x11 1578 1600* 1600* 1600*
x21 0 0 0 0
x12 867 867 1012 895
x22 1000* 1000* 1000* 1000*
--------------------------------------------------------
y11 1578 1600 545 428
y21 0 0 1000 1000
y12 867 867 2067 2067
y22 1000 1000 0 0
--------------------------------------------------------
y112 0 0
y212 1000 1000
y121 1055 1172
y221 0 0
--------------------------------------------------------
z1 0.675 0.743 1.000* 0.632
z2 1.000* 1.000* 1.000* 1.000*
w11 0 1.000* 0.955 0
w12 1.000* 1.000* 0 1.000*
w22 1.000* 1.000* 1.000* 1.000*
--------------------------------------------------------
d1 $ 2300* 2300* 2300* 2300*
d2 L 590 792 800 563
--------------------------------------------------------
m12 $ 0 0
m21 L 197 395
--------------------------------------------------------
e1 $ 700 700 700 700
e2 L 350 350 350 350
First, we assume that the affiliates cannot interact at all: both
physical flows and capital transfers between the affiliates are
prohibited. This is case 1. Affiliate 1 (in the USA in our numerical
example) is short of funds in the example while affiliate 2 (in
England) has ample funds as is seen from the fully utilized
borrowing capability in the former and the unutilized borrowing
capability in the latter.In case 2 we relax the barrier to capital transfers between the affiliates. In the numerical example it is optimal for the multinational firm to grant a loan of L197 from affiliate 2 to affiliate 1. The value of the objective function of the multinational firm is increased, because lifting the barrier on capital transfers alleviates the shortage of funds in affiliate 1, which borrows from affiliate 2.
Case 2 omits, however, the important fact that the affiliates of the multinational business enterprises may trade their products with each other. We include the possibility of interaffiliate trade in case 3. (The complete model presented in the previous chapter was developed particularly for this general case. Suitably reduced versions are applied in the other cases.) In the numerical example the affiliates now trade in both directions in the different products. The composition of the accepted investment options is altered with the changing situation of capital rationing. A capital transfer of L395 occurs in the form of an interaffiliate loan from affiliate 2 to affiliate 1. This loan is not the only financial flow between the affiliates in case 3. The interaffiliate payments for the interaffiliate trade amount to $600 and L738.50 respectively. The net flow from affiliate 2 to affiliate 1 is thus L833.50. The value of the objective function in the numerical example is increased again, since with the introduction of the interaffiliate trade the multinational firm can better utilize its pattern of production costs and sales potential.
Next, let us observe what happens in the numerical example if the interaffiliate capital transfers were prohibited by the respective governments, but the inter affiliate trade and the payments on this trade could still be employed by the multinational firm. The flow of funds from affiliate 2 to affiliate 1 would not cease! The interaffiliate payments for the interaffiliate trade, which would be optimal for this case 4, would amount to $600 and L820.40 respectively. This means a net flow of L520.40 towards affiliate 1. Funds needed in affiliate 1 are thus acquired from affiliate 2 with the help of interaffiliate trade. This is indicated by the fact that in case 3 a net flow of L438.50 resulted from the inter affiliate trade, while now in case 4 it is L520.40. If the transfer prices had also been made decision variables the distinction would have been more marked. The value of the objective function is decreased when compared with case 3, where there are no barriers between the interaffiliate capital transfers. When compared with the completely segmented case 1, the value of the objective function is increased.
No general conclusions can be drawn from the four hypothetical examples discussed. Nevertheless, they clearly indicate that barriers to capital flows are in adequate in segregating the national capital markets from each other in the presence of multinational business enterprises. This arises from the proposition that the multinational firm can circumvent the barriers by employing interaffiliate trade as suggested by our simulated numerical examples. This result is in agreement with the earlier results referred to in Section 1.1.
In the presence of multinational firms a necessary condition for segregating the markets would be barriers both to capital transfers and trade between the affiliates, as in case 1 of the numerical example. On the other hand, when barriers to capital flows exist, but interaffiliate trade is allowed (case 4), the value of the objective function for the multinational firm is decreased in our numerical example when compared to the case of no barriers on interaffiliate trade and capital transfers (case 3). One tentative interpretation of this behavior would be to say that partial segmentation is indicated in case 4. Thus, two different kinds of segmentation occur in our numerical example: (l) The effective segmentation of case 1, where neither capital transfers nor trade is allowed between the relevant nations, and (2) the partial segmentation of case 4, where the capital transfers, but not trade, are prohibited by the respective governments.
Indices
k,h = indices for affiliates. They are also used to indicate the
relevant countries and currencies.
k = 1,...,K h = 1,...,K (K = 2)
(k = 1 the headquarters in the USA)
(k = 2 the subsidiary in England)
i = index for product. i = 1,...,I
(I = 2)
j = index for investment option. j = 1,...,J(k)
(J(1) = 1, J(2) = 2)
Parameters
tr(k) = the translation coefficient applied on the after tax yield
in affiliate k.
(tr(1) = 1$/$ tr(2) = 2$/L)
t(k) = the absolute income-tax rate in country k.
(t(1) = 0.47 t(2) = 0.52)
p(ik) = the sales price of product i in country k in the local
currency.
(p(11) = $5 p(12) = L 2.0)
(p(21) = $3 p(22) = L 2.7)
c(ik) = the unit variable cost of product i produced in affiliate
k, stated in the local currency.
(c(11) = $1.8 c(12) = L0.8)
(c(21) = $1.0 c(22) = L1.0)
p(ikh) = the unit transfer price of product i transferred from
affiliate k to affiliate h, stated in the host country
currency of the exporting affiliate k.
(p(112) = $1.7 p(121) = L0.9)
(p(212) = $0.9 p(221) = L0.7)
v(hk) = the exchange rate of currency h in country k.
(v(21) = 2$/L v(12) = 0.5L/$)
uc(ik) = the absolute rate of the ad valorem duty imposed on
product i imported by affiliate k. The duty is paid by the
importing affiliate k in the local currency.
(uc(11) = 0.24 uc(12) = 0.22)
(uc(21) = 0.24 uc(22) = 0.22)
ut(ihk) = the unit transportation cost of an item of product i
transferred from affiliate h to affiliate k. It is paid by
the importing affiliate k in the local currency.
(ut(112) = L0.06 ut(121) = $0.12)
(ut(212) = L0.12 ut(221) = $0.24)
rd(k) = the absolute rate of interest on the borrowing by
affiliate k from the local money market.
(rd(1) = 0.08 rd(2) = 0.11)
rm(kh) = the absolute rate of interest on the interaffiliate loan
granted by affiliate k to affiliate h.
(rm(12) = 0.09 rm(21) = 0.09)
sm(kh) = the absolute stamp-duty rate on the interaffiliate loan
granted by affiliate k to affiliate h. The stamp-duty is
paid by affiliate h raising the loan.
(sm(12) = 0.01 sm(21) = 0.005)
re(k) = the absolute rate of interest on the closing cash of
affiliate k deposited locally in bank.
(re(1) = 0.08 re(2) = 0.08)
g(k) = the total expenditure of investing in the capacity
increase in affiliate k, stated in the local currency.
(g(1) = $1200 g(2) = L700)
rg(k) = the coefficient for calculating one annuity of the
capacity increase investment cost in affiliate k. For
details see the discussion in Section 2.3.
(rg(1) = 0.4164 rg(2) = 0.3292)
(E.g. the latter indicates a life-span of four years
with a 12% interest rate.)
f(jk) = the total expenditure of the j:th investment option for
affiliate k, stated in the local currency.
(f(11) = $500 f(12) = L110)
(f(22) = L 90)
rf(jk) = the coefficient for calculating one annuity of the total
expenditure of the j:th investment option for affiliate k.
For details see the discussion in Section 2.3.
(rf(11) = 0.2774 rf(12) = 0.4164)
(rf(22) = 0.3292)
s(jk) = the annual earnings from the j:th investment option of
affiliate k, stated in the local currency.
(s(11) = $200 s(12) = L55)
(s(22) = L40)
U(k) = the fixed and predetermined costs in affiliate k, stated
in the local currency.
(U(1) = $3000 U(2) = L2000)
X(ik) = the sales potential of product i for affiliate k.
(X(11) = 1600 X(12) = 1200)
(X(21) = 1000 X(22) = 1000)
Hb(ik) = the initial inventory of product i in affiliate k.
(Hb(11) = 300 Hb(12) = 250)
(Hb(21) = 200 Hb(22) = 200)
He(ik) = the closing inventory required for product i in affiliate
k.
(He(11) = 300 He(12) = 250)
(He(21) = 200 He(22) = 200)
a(ik) = the capacity usage in affiliate k per an unit of product
i.
(a(11) = 2.2 a(12) = 1.5)
(a(21) = 2.5 a(22) = 1.8)
Y(k) = the initial capacity in affiliate k.
(Y(1) = 3000 Y(2) = 2500)
b(k) = the additional capacity that can be acquired in affiliate
k.
(b(1) = 700 b(2) = 600)
pp(ik) = the cash portion of p(ik).
(pp(11) = $3.0 pp(12) = L1.5)
(pp(21) = $2.5 pp(22) = L2.0)
pp(ikh) = the cash portion of p(ikh).
(pp(112) = $1.5 pp(121) = L0.7)
(pp(212) = $0.6 pp(221) = L0.5 )
cp(ik) = the cash portion of c(ik).
(cp(11) = $1.8 cp(12) = L0.6)
(cp(21) = $0.5 cp(22) = L0.4)
Up(k) = the cash portion of U(k).
(Up(1) = $3000 Up(2) = L2000)
Eb(k) = the initial cash in affiliate k, stated in the local
currency.
(Eb(1) = $500 Eb(2) = L250)
Ee(k) = the minimum closing cash in affiliate k, stated in the
local currency.
(Ee(1) = $700 Ee(2) = L350)
D(k) = the maximum borrowing capability of affiliate k from the
local money market, stated in the local currency.
(D(1) = $2300 D(2) = L800)
M(k) = the maximum acceptable level of interaffiliate lending by
affiliate k, stated in the local currency.
(M(1) = $2000 M(2) = L700)
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[17] Robbins, Sidney M. & Stobaugh, Robert B. Money in the Multinational Enterprise: A Study of Financial Policy. With a simulation model constructed by Daniel M. Schydlowsky. New York: Basic Books, Inc., 1973.
[18] Salmi, Timo. "The Multinational Firm, a Mathematical Programming Model Building Approach: A proposition for Research Work; Part II," The Finnish Journal of Business Economics, Vol. 21, No. 2 (1972), 134-147.
[19] Salmi, Timo. "Some Aspects of Production and Profit Adjustment in the Multinational Firm," an unpublished paper presented at the European Institute for Advanced Studies in Management/Helsinki School of Economics seminar, March 14-16, 1973, in Helsinki. Published in Finnish in The Finnish Journal of Business Economics, Vol. 22, No. 2 (1973), 114-126.
[20] Salmi, Timo. Joint Determination of Trade, Production, and Financial Flows in the Multinational Firm Assuming Risky Currency Exchange Rates: A Two-Stage Linear Programming Model Building Approach. Doctoral dissertation. The Helsinki School of Economics. Helsinki, Finland: Oy Gaudeamus Ab, March 1975. (Show abstract)
[21] Slavich, Denis Michael. The International Financing Decision: A Programming Approach. Doctoral dissertation. Alfred P. Sloan School of Management, Massachusetts Institute of Technology, June 1971.
[22] Solnik, Bruno H. "An Equilibrium Model of the International Capital Market," Journal of Economic Theory, Vol. 8, No. 4 (August 1974), 500-524.
[23] Solving International Accounting Problems: Policies Procedures for Consolidation, Reporting, Translation. Prepared and published by Business International Corporation, 757 Third Avenue, New York, N.Y. 10017, 1969.
[24] Velasco, Virgilio T. A Financial Planning Model for the Multinational Firm. Doctoral dissertation. Indiana University, Graduate School of Business, 1973. [25] Wasiljeff, Yrjö. The International Capital Market Segmentation in the Multinational Corporation Introduced as Models and Examples. Unpublished master's thesis. The Helsinki School of Economics, February 1976.
[26] Weingartner, Martin H. Mathematical Programming and the Analysis of Capital Budgeting Problems. London: Kershaw Publishing Company Ltd, 1967.
2) It is very difficult to obtain permission for the use of the confidential internal data of multinational corporations. For this reason we must use fictitious data to simulate real-life decision- making situations.
3) Arya [3, pp. 9-67] provides a fairly comprehensive survey of the development of capital budgeting decision theory.
4) Although advocated already earlier by scholars of economics the managerial application of the internal rate of return and cut-off at the marginal cost of capital can with good reason be attributed to Dean in 1951. Dean's approach is widely applied by managers of business enterprises as a sophisticated rule of thumb for the capital budgeting decisions. However, Lorie and Savage [11] and Weingartner [26] showed that Dean's approach is not consistent with the maximization of the net worth of the firm.
5) They also demonstrated the fundamental fact that the cost of capital to the firm need not be known in advance, because the linear programming approach solves it simultaneously with the operating and financing decisions of the firm.
6) This is consistent with the result in [4] demonstrating the variability of the opportunity cost of capital along the time- dimension.
7) Translation is needed, because the yields for the subsidiaries located in different countries are denominated in foreign currencies. For a discussion on translation problems see e.g. [23, Ch. 3].
8) We use the word "affiliate" for both the headquarters and the subsidiaries of the multinational firm. It is assumed for expository convenience that no more than one affiliate of the firm is located in any country.
9) For a relevant discussion see [26, Ch. 3 and Sec. 8.4].
10) The inclusion of stochastic currency exchange rates (i.e. the inclusion of the so-called currency risk) in linear programming models for joint operating and financial planning has been demonstrated by Jääskeläinen and Salmi [9] in 1974, and Salmi [20].
11) Operations research models for optimal transfer pricing decisions in the multinational firm have also been constructed by Petty [16] and Nieckels [15]. These models treat, however, the other decision variables as predetermined.
12) The generic method for obtaining this opportunity cost rate would be the one advocated by Charnes, Cooper and Miller [4], but their suggestion cannot be applied here, since it would require a multiperiod model, which might be too large to be computationally feasible for multinational business enterprises. Instead, an iterative procedure for finding plausible q(k)-values might be devised. We assume, however, that the decision maker is able to give subjective estimates for these opportunity cost rates. Furthermore, when compared with the other congenial operations research models for the multinational firm, no actual simplification is involved.
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Other scientific publications by Timo Salmi in electronic format
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