The History Of Foreign Direct Investment

Published Date: 02 Nov 2017

Executive Summary

Introduction

This report provides an analysis of investment decision making of Teltec Plc by looking at Net Present Value (NPV) when they expand their business into a country called Farland.

Deficiencies information in decision making process.

1.1 Resource Availability

The report also investigate that there is some deficiencies information that exist in the decision making process which Teltec Plc should take under consideration. The deficiencies information that should have in the information is resource available in Farland. Teltec should know what resource that Farland has in terms of land, water, labour and other. Besides that, Teltec Plc should know whether there is any pollution that affects the environment in Farland since it has been ravaged by war. Thus, all this will affect Teltec Plc. Number of years since Farland has been ravaged by war.

1.2 Number of years since Farland has been ravaged by war

Moreover, the information not provide the years in which Farland has been affected by war. This is important to be considered because Teltec Plc can measure the number of years that Farland faced unstable economy, political and others.

1.3 Cultures and language

It is important for a company to know the cultural distance between the companies that we want to invest. In the given information, there is no cultures or language that have been used by Farland. If they are using different language and social lifestyle, it will increase the uncertainty to Teltec and it will become difficult for Teltec to transfer human resource or technology into that country.

Useful information to be considered

Discount factor

This is important because it is a minimum rate of return starting point for the business case financials. Besides that, discount factor is used to derive the current year’s value. The variable of discount rate with higher rates is applied to the project timeline. For example, the project for Teltec Plc to Farand is for 5 years, so the discount rate factor should be calculate until 5 years basis.

Depreciation

The depreciation is non-cash expense that shows the use of asset by the company, it is useful since it will reduce the taxable income when calculating the NPV. Since it is non-expenses cash for the company, therefore it must to exclude the figures of depreciation in in calculating net present value.

Impact on the return from such investment

Teltec Plc should know the impact in their profit when they are planning to invest in Farland. This is useful information for the decision making process in investment. Besides that, Teltec should look at internal (management) and external (political, economic risk and others) problem that can give an impact towards their profitability.

Other factors should be considered.

Infrastructure

This should be considered in terms of industries and business in the foreign country whether they can easily access to that foreign infrastructure. For instance, Teltec should know how easy to deal with the electricity, internet, roads and others in Farland is it easy or not.

Government laws and regulation

The company should consider law and regulation within the country that they want to invest. Asymmetric information can be happen if Teltec Plc does not do a research towards what is the government laws and regulation that have in Farland, and they must follow the laws in Farland. The laws and regulation might be in terms of government working to protect the local products such as the government implement tariff, loan guarantees and others.

Degree of competition

The other factor that Teltec should consider is the number of competitors that selling the same product which is telecommunication equipment. When there is high competition in the market in foreign country, there is no profitable for Teltec to enter that country since the market in Farland already mature.

Question (b)

Political risk is a risk that will affect the profitability and operation of the business because of the changes that happened in a country’s government or the regulatory environment. The political risk is a long term risk since it is difficult to predict, so this is an important aspect for the investors and companies to examine the stability of the country that they want to invest.

In this case, Teltec Plc wants to expand their business to another country which is Farland that is less developed country which has been ravaged by war and unstable governments for a number of years. Thus the risk is high for Teltec Plc.

However, the political risk also can be measured through qualitative and quantitative analysis. As stated by (McCaffrey, et. al., 2012), knowledge and opinion about the political problem is considered as qualitative analysis while quantitative analysis is depends on economic and political data of that country. Policy changes can assess the political risk of the investment in Farland. This means that when the government make changes on the policies this will affect the business of Teltec Plc. For example, when there is a widespread poverty, high unemployment and nationalistic pressure that will lead to policy changes of Farland. The impact on the policy changes in Farland towards Teltec Plc it can enforce more restrictions on Teltec Plc by limiting their access to financing and trade thus will make Teltec Plc difficult to operate in Farland.

Furthermore, Farland governments will implement tax such as tariff to control imported product from Teltec Plc by increase the price of the imported goods and services that will lead to increase in price for the customers. The customer will not spend more money in buying expensive or high price product, thus it will affect the profitability of Teltec Plc. According to (Zoldak, 1999), the national government have their own right to control on laws or regulation and tariff.

Moreover, the economics in Farland also will be affected when they are having political risk. Farland will experience high rate of inflation which will give an impact on the profitability of Teltec Plc. Political risk will lead to high inflation. According to (Rajwani, 2013), political risk was caused by an increased high unemployment, high inflation and long standing corrupt governments. Other than that, Teltec Plc will face currency risk due to political problem that occur in Farland since they are exporting their product to Farland. For example, the fluctuation of the exchange rate will affect the price that Teltec Plc need to pay and this could be either higher or lower. It also will effect on future costs and future cash flows from the international investment.

However, election will affect market as well as economy and political of that country. As from this case, when Farland having an election, it will affect the business in Teltec in terms of reduce their profit and asset. This has been proved by (Kihurro, 2013), Kenya was having forthcoming elections in March 2013, thus this will lead to huge impact in political risk and affects international country risk that will affect their operating profits or value of their assets. The election violence can depressed all the investor’s confidence to invest in the country. Thus, the number of investors that want to invest in Farland will reduce due to the election.

Other than that, the expropriation of an asset will create political risk because it is connected to the local government in which the local government will expropriate the company’s asset to get their benefit from its property. The fixed asset of Farland such as an extractive industry might be attractive aim to the government for expropriation. The government will increase the tax and royalties toward Farland. Hence, this is the potential loss towards Farland.

Question (c)

Teltec Plc is considering in expanding their market into Farland by increasing exports or entering joint venture with local company based in Farland. There are some advantages and disadvantages that Teltec will face when Teltec Plc expand their business in international country. There are:

Exporting

Export is selling a good to foreign country as a way to gain more profit. The advantages of export are Teltec Plc can increase their market size and brand awareness in foreign country. Thus, it will help them in increase of their reputation. By exporting their product to international, they can create more customers to aware about their existence in the market.

Other than that, exporting protect Teltec Plc product in the event of world recession. As the saying ‘don’t keep your eggs in one basket’ is correct as Teltec Plc can spread their risk across different market. For example, if the market in Farland is suffer from any recession, it will cause on lower demand or customer’s change preferences, thus this will not affect sales and profit that have in the home country.

While, the disadvantage of exporting is it may involve government regulations such as the availability of trade barriers. For example, government in Farland will implement tariff and quotas to limit the amount of exporting for Teltec. Teltec must follow the regulations that have been set by the government in Farland.

When Teltec Plc depends on exporting, it will create a problem in terms of maintaining market share and long distance communication between different countries. Moreover, it is important for Teltec to know the economic geography area of the trade flow in the long distance country which is Farland. When there is a distance between countries, the transportation cost might occur for Teltec Plc. Teltec also must bear the information cost about foreign market. Thus, establishing the relationship with Farland are higher.

Joint Venture

Joint venture is two or more business parties that agree to pool their resources to complete their specific task. The advantage in joint venture is it can provide the company to gain new capacity and expertise. For example, when Teltec Plc wants to expand their business by joint venture with one of the company in Farland, Teltec can increase their employee’s expertise with different organization and different country.

Besides that, joint venture also can reduce the cost of the company. For instance, Teltec and one of the companies in Farland wish to produce new telecommunication equipment, they will share the cost of the project and thus this will reduce their individual risk.

Whereas, the disadvantages of joint venture are it takes time for Teltec to build the right partnering and relationship with another business in Farland. They may have a problem that can arise such as they maybe have different cultures and management style since they are in two different countries.

The other disadvantages are it can create conflicts between the partners. According to (Carter, 2013) conflicts and disputes may arise between the partners on how to manage the company. In this case, Teltec may want to manage a company with a certain way but Farland’s company may have different idea than Teltec. Thus, this will create mismanagement because it does not have clearly roles and responsibilities.

Foreign Direct Investment

Foreign Direct Investment (FDI) is an investment that made by a company in one country into a company in international country by expanding their business in that country. There are some advantages and disadvantages in foreign direct investment.

The potential benefit in FDI is it can increase the level of investment in that country. Normally local investment and local capital market is not well develop or enough. Hence, Teltec Plc can encounter the capital requirement for large investment project by investing in other country which is Farland. Moreover, Teltec can obtain a direct source of external capital when investing in Farland.

Furthermore, FDI can improve in knowledge transfer and technology diffusion by outsourcing the knowledge. For example, Teltec Plc can outsource their knowledge in Farland especially in terms of information technology sector. This indicates that, FDI is providing technical expertise in the working process with world class technology.

However, the disadvantages in foreign direct investment are it is a risky investment that the company must consider in terms of political condition and economic condition of the country that they want to invest. For instance, Teltec make a risky investment when they want to invest or expand their product in Farland because Farland has been ravaged by war and it is unstable governments for a number of years. The government of Farland can take control over Teltec’s asset and property.

The other disadvantage is the different language and cultures for two different countries that they have to adapt. In this case, Teltec Plc might face communication problem when interact with people in Farland. Thus might result in miscommunicating with the operation in Farland.

Question 2

Foreign Direct Investment (FDI) is a process when a company in one country acquire ownership of another country’s asset for the purpose of distribution, production and other activities to expand their business. According to (Kolodkin, 2013), one of the external sources of finance is through FDI which the company that have a limited amount of amount can receive extra money from wealthier country.

When the regulatory framework allows FDI, the most important influence in FDI is from economic factors. For example, when there is a lack of economic growth in the country, it will affect the demand for the investment as well as demand for goods and services produced by the foreign partners when a firm invest in the foreign market.

During the 2008, the world financial systems have faced financial and economic crisis. Some of financial institution and firms in United States experienced bankruptcy and insolvency. This happened because of a wider underlying of condition in the financial services industry. Thus, it affects financial markets in other country as well such as developing country like Iceland, Indonesia and others that had turn into International Monetary Fund. Hence, it gives a result on global economic downturn which is recession.

Moreover, FDI has a strong relationship with economic growth (Sanderatne, 2011). The effect of FDI on economic growth will depend on economy condition in that country. During 2003 to 2007, FDI shows upward trends by steady world economic conditions. But it started to give an impact when there is economic and financial crisis in 2008. (United Nation Conference on Trade and Development, 2009) stated that a developed country is the most affected by decline in FDI inflows in 2008 due to recession. For example, United States (US) is one of developed countries. In 2008, US experienced financial instability due to subprime crisis which lead them to deterioration of investment. However, China is succeeding in having inward FDI as compared to the other country during the financial and economic crisis. This has been proved by (Alfaro, 2010) that China has a clear positive shift in sales distributions in 2007 to 2008 which is during the financial and economic crisis.

The economic downturn gives an impact towards FDI especially in falling in their profits, reducing the company’s sales, dropping in stock prices and others. (Beule, et. al, n. a) suggest that falling FDI in 2008 gives an impact on less demand, reduce capacity to finance since the economy is not stable, falling in stock price and others.

During the recession, it will cause on decreasing the economic activity which will shrinkage the demand of borrowing. Federal Reserve will increase the money supply in order to decrease the interest rate (Feuntes, 2013). The investors will feel unsecure and fear on the economy condition during the recession which lead to the investors to dram back the money that they invested because a fall of interest rate that is affected from shrinking of global economy.

Apart from that, financial crisis will create a credit crisis for the firms to invest in a foreign country because it will effect on the firm’s savings. (Sauvant et. al., 2009) said that financial crisis will result in credit crunch which affect the capability of the firm to invest in abroad. Thus, the demand of FDI will worsened because of the economic situation in foreign market. Moreover, the credit crisis that the company might face in FDI during financial and economic crisis is when the firm has low profit and tighter the credit situation that will lead to deteriorate the company’s capability to finance their project in abroad.

Other than that, merger and acquisition (M&A) is a combination of two companies or buying a company to create a new company to increase their market share and control undervalued assets. M&A also been affected throughout the economic downturn.

The fall in global FDI has been affected cross-border M&A when there is a financial and economic crisis in 2008. Cross border M&A has a relationship with FDI flow. For instance, when the total cross border M&A is decreasing, give a significant impact to the FDI flows. (United Nation Conference on Trade and Development, 2009) proved that a dramatic decline in M&A was in 2009 as compared to 2008 and the increase or decrease in the value of FDI is depends on which industries in that time such as in 2008 the value of cross border M&A for sales in oil and other commodities in increasing while the value of cross-border M&A is decreasing in manufacturing industries.

Throughout the financial and economic crisis, the bank will decrease the loan or sources of funding for the company. Thus it makes the company not enough sufficient money to do M&A activity since the banks do not lending money to their customers. According to (Burksaitiene, 2010), when there is a decline profit in the developing country it will result in decline in syndicated bank loans that the company have a limited amount of financing for investment. Hence, buyout of transaction also reduced cross-border M&A.

Moreover, the impact of cross-border M&A due to economic downturn is the equity investment will decreasing which is the money that a company invested from its holders or owner of the investment because of stock prices will go up and the investors who invested in stock market will feel unsecure and losing their money. This is because, during the financial crisis it makes the debt and equity financing become difficult (Burksaitiene, 2010).

In addition, when thru financial crisis, financial institution has been affected, and a financial service was declined significantly and more diversified firm operating in other places. Thus, the changes in the crisis will result on the commercial bank to expand into other geographic area from merger and acquisition.

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