Foreign Domestic Investment - Essay Example

Vernon’s product life-cycle theory was initially developed in the US because 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 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 of 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 the establishment of production facilities in many countries simultaneously.

Based on the stiff competition that is been experienced in the current business atmosphere, many countries are focused on supporting their local companies by offering incentives such as tax subsidies and training of their workforce. One of the major reasons 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 on establishing new production facilities that act as major sources of employment for the 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 amounts 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 risks 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 to provide a fair position of the company's financial position. Political risks entail the complications that local and foreign businesses may face due to a political change. Besides macroeconomic factors, political risks can be caused by social policies as well as changes in investment, labor, 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 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 future cash flows. This is followed by using the normal cost of capital which is adopted by domestic capital budgeting.
The need for expansion in foreign countries has forced many firms to emulate various strategies to expand their tangible and intangible assets. Two notable strategies that the majority of organizations adopt are forward and backward internalization. Forward internalization come about when a multi-national corporation with intangible assets makes a foreign domestic investment to utilize the assets. Another aim of forward internalization is to internalize externalities that may be produced by the assets. Backward internalization comes about when multinational corporations acquire foreign organizations to access intangible assets that are possessed by foreign companies. Just like in forward internalization, another objective of backward internalization is to internalize the externalities derived from the acquired assets.
As a result of fluctuating exchange rates, finance officers of foreign investment companies should emulate effective ways of stabilizing their cash flows thus reducing the occurrences of uncertainties in their budgets. Apart from the foreign exchange exposure, the officers must take into consideration the currency exchange risks while undertaking capital budgeting. Currency exchange risks entail the financial risks that are caused by unexpected changes in the rate at which two currencies exchange (Homaifar, 2004). Being mostly experienced by foreign investments and multinational firms, currency risks may result in adverse financial problems if not addressed. In their efforts to protect their firms from the negative implication of exchange rate risks, managers adopt various strategies. These include the application of foreign exchange derivatives such as swaps, forward contracts, and options among others (Moosa, 2003). Similarly, managers can use money markets to mitigate foreign exchange risks. One of the key ways of incorporating currency exchange risks is by discounting foreign currency cash flow by the use of the foreign discount rate. Another way is to convert the currency exchange risk using future spot rates while at the same time using a domestic discount rate to convert discount domestic cash flows. Read More