Running head: FOREIGN DOMESTIC INVESTMENT 8th November 2013 Vernon’s product life-cycle theory of FDI was developed by Raymond Vernon. According to the theory, a firm starts by exporting its products after which it emulates foreign direct investment…
By establishing production facilities in other countries especially where the cost of production is low, the firm starts to import its products back to home. Vernon’s product life-cycle theory was initially developed in US due to the fact that the most of new products were initiated in the US market. As more regions became developed, the theory was emulated by other countries such as China and Japan among other countries. One of the notable strengths of the Vernon’s product life-cycle theory is that it clearly explains the historical development of foreign domestic investment (Moffett et al, 2009). Nevertheless, based on the complexity in the production process globally, Vernon’s product life-cycle theory cannot neatly hold. For instance, as many countries initiate production systems, new products are being introduced at the same time in addition to establishment of production facilities in many countries simultaneously. Based on stiff competition that is been experienced in the current business atmosphere, many countries are focused at supporting their local companies by offering incentives such as tax subsidies and training of their work force. One of the major reasons as to why host countries, resist cross-border acquisitions is that they view them as foreign companies who are aimed at taking over their local firms without creating employment opportunities. On the other hand, host countries, view green field investments as economic drivers that are focused at establishing new production facilities that acts as major sources of employment for the local residents (Wang, 2005). Additionally, some host companies are viewed as competitors whose aim is to create products that are similar to those of the host companies. As a result, the local firms are faced with fewer sales leading to reduced amount of tax paid to the government thus resulting to slow development of the host countries. As local companies adopt foreign domestic investment, they are faced with various risks that range from currency risk to political risks. Based on the need to produce a budget that entails all the assets and liabilities that firms have at a certain date, it is imperative to incorporate the risks so as to provide fair position of the companies’ financial position. Political risks entail the complications that local and foreign businesses may face due to a political change. Beside macroeconomic factors, political risks can be caused by social policies as well as changes in investment, labour and changes in development among others. Political risks can be divided into macro political risks and macro political risks. While micro political risks are specifically related to a project, macro political risks affect all sectors of a country. During capital budgeting, firms should incorporate political risks in various ways. First, an organization can adjust the cost of capital upwards in order to indicate the impact of political risk. This is followed by discounting the expected cash flows at an increased rate. Secondly, a firm can deduct insurance premiums associated with political risks from the future cash flows. This is followed by using the normal cost of capital which is adopted by the domestic capital budgeting. The need for expansion in foreign countries has forced many firms to emulate various strategies in order to expand their tangible and intangible assets. Two notable ...
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