Incoterms 2010 and International Business - 101
Incoterms 2010 and International Business - Wild - Chapter 15 - QUIZ
Incoterms 2010 and International Business - 101
International Business: The Challenges of Globalization, 8th Edition, Wild & Wild
Incoterms 2010 and International Business - Wild - Chapter 15 - QUIZ
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International Business, 8e (Wild/Wild)
Chapter 15 Managing International Operations
1) Which of the following terms refers to the decision of whether to produce a component internally or to outsource it from another company?
- A) buyer decision process
- B) decision problem
- C) per curiam decision
- D) make-or-buy decision
Answer: D
Skill: Concept
Difficulty: Easy
LO: 15.1: Describe how global production and logistics decisions are made
2) The process of assessing a company's ability to produce enough output to satisfy market demand is called ________.
- A) capacity planning
- B) lean production
- C) process management
- D) product structure modeling
Answer: A
AACSB: Application of knowledge
Skill: Concept
Difficulty: Easy
LO: 15.1: Describe the elements to consider when formulating production strategies.
3) Transportation costs are one of the driving forces behind the globalization of the ________ industry.
- A) health care
- B) publishing
- C) software
- D) steel
Answer: D
AACSB: Application of knowledge
Skill: Concept
Difficulty: Easy
LO: 15.1: Describe the elements to consider when formulating production strategies.
4) Which of the following statements is true regarding location economies?
- A) The demand and supply factors heavily influence the productivity of a location.
- B) They apply only to service providers.
- C) Each production activity generates more value in a particular location than elsewhere.
- D) They are restricted to business activities that involve product manufacturing.
Answer: C
AACSB: Application of knowledge
Skill: Concept
Difficulty: Moderate
LO: 15.1: Describe the elements to consider when formulating production strategies.
5) ________ refers to the concentration of production facilities in one location.
- A) Lean production
- B) Continuous production
- C) Centralized production
- D) Horizontal integration
Answer: C
AACSB: Application of knowledge
Skill: Concept
Difficulty: Easy
LO: 15.1: Describe the elements to consider when formulating production strategies.
6) ________ refers to a situation in which facilities are spread over several locations, with one facility for each national business environment in which the company markets its products.
- A) Continuous production
- B) Decentralized production
- C) Vertical integration
- D) Lean production
Answer: B
Skill: Concept
Difficulty: Easy
LO: 15.1: Describe the elements to consider when formulating production strategies.
7) A British toy company manufactures all of its product lines in a single facility in Europe. Which of the following is the company demonstrating?
- A) continuous production
- B) lean production
- C) centralized production
- D) horizontal integration
Answer: C
AACSB: Analytical thinking
Skill: Application
Difficulty: Hard
LO: 15.1: Describe the elements to consider when formulating production strategies.
8) An Asian jewelry company maintains production facilities in South Korea, Vietnam, and Malaysia. Which of the following is the company exemplifying?
- A) lean production
- B) decentralized production
- C) vertical integration
- D) continuous production
Answer: B
AACSB: Analytical thinking
Skill: Application
Difficulty: Hard
LO: 15.1: Describe the elements to consider when formulating production strategies.
9) A company that sells differentiated products may maintain the ability to respond quickly to changing buyer preferences by utilizing ________.
- A) vertical integration
- B) decentralized production
- C) lean production
- D) continuous production
Answer: B
Skill: Concept
Difficulty: Easy
LO: 15.1: Describe the elements to consider when formulating production strategies.
10) The decentralization of production facilities is a typical policy for companies that pursue ________.
- A) a multinational strategy
- B) a global strategy
- C) mass customization
- D) vertical integration
Answer: A
AACSB: Application of knowledge
Skill: Concept
Difficulty: Easy
LO: 15.1: Describe the elements to consider when formulating production strategies.
11) The centralization of production facilities is a typical policy for companies that pursue ________.
- A) horizontal integration
- B) product differentiation
- C) a global strategy
- D) a multinational strategy
Answer: C
Skill: Concept
Difficulty: Easy
LO: 15.1: Describe the elements to consider when formulating production strategies.
12) Companies with centralized production facilities are often pursuing ________ strategies.
- A) low-cost
- B) differentiation
- C) retrenchment
- D) combination
Answer: A
Skill: Concept
Difficulty: Easy
LO: 15.1: Describe the elements to consider when formulating production strategies.
13) Deciding the sequence of operations a company will use to create its product is called ________.
- A) product planning
- B) capacity planning
- C) location economies
- D) process planning
Answer: D
Skill: Concept
Difficulty: Easy
LO: 15.1: Describe the elements to consider when formulating production strategies.
14) Which of the following determines the process that a company will use to create its product?
- A) a firm's multinational strategy
- B) a firm's global strategy
- C) a firm's corporate-level strategy
- D) a firm's business-level strategy
Answer: D
Skill: Concept
Difficulty: Easy
LO: 15.1: Describe the elements to consider when formulating production strategies.
15) Which of the following will a company that is pursuing a low-cost leadership strategy most likely use for creating its product?
- A) implement handcrafted artisanship
- B) manufacture in large production batches
- C) manufacture components in-house
- D) customize products for each customer
Answer: B
Skill: Concept
Difficulty: Easy
LO: 15.1: Describe the elements to consider when formulating production strategies.
16) Deciding the spatial arrangement of production processes within production units is called ________.
- A) facilities layout planning
- B) capacity planning
- C) process planning
- D) location economies
Answer: A
Skill: Concept
Difficulty: Easy
LO: 15.1: Describe the elements to consider when formulating production strategies.
17) Which of the following factors has the least effect on facilities layout planning?
- A) supply of land in a nation
- B) cost of land in a nation
- C) a firm's production process
- D) age of the company
Answer: D
Skill: Concept
Difficulty: Easy
LO: 15.1: Describe the elements to consider when formulating production strategies.
Scenario: Wilson Industries Inc.
Wilson Industries Inc. is a multinational firm that designs and produces premium leather bags for major destinations worldwide. The company's board of directors is meeting to discuss changes that might be needed in the company's operations.
18) The board plans to examine Wilson's ability to produce enough bags to satisfy their customers' demands. This evaluation is known as ________.
- A) capacity planning
- B) process planning
- C) lean production
- D) product structure modeling
Answer: A
AACSB: Analytical thinking
Skill: Application
Difficulty: Hard
LO: 15.1: Describe the elements to consider when formulating production strategies.
19) If Wilson Industries selects a new area for its production units, the company will be implementing ________.
- A) capacity planning
- B) process planning
- C) facilities location planning
- D) product structure modeling
Answer: C
AACSB: Analytical thinking
Skill: Application
Difficulty: Hard
LO: 15.1: Describe the elements to consider when formulating production strategies.
20) The board will also examine new production techniques the company could use to create its product. This examination is a part of ________.
- A) capacity planning
- B) process planning
- C) facilities location planning
- D) centralized production
Answer: B
AACSB: Analytical thinking
Skill: Application
Difficulty: Easy
LO: 15.1: Describe the elements to consider when formulating production strategies.
21) If the board discusses the spatial arrangement of production processes within Wilson's production facilities, they will be engaging in ________.
- A) capacity planning
- B) facilities location planning
- C) process planning
- D) facilities layout planning
Answer: D
AACSB: Analytical thinking
Skill: Application
Difficulty: Hard
LO: 15.1: Describe the elements to consider when formulating production strategies.
Scenario: Hafstrom Motors
Based in Kentucky, Hafstrom Motors has always used spare parts made in America for its automobiles. However, sales and profits have slumped over the past three years. A senior manager at the company comes up with new strategies for improving the firm's production activities.
22) The senior manager recommends that Hafstrom obtain auto parts from a country where production activities would generate more value than it would generate elsewhere. He wants to take advantage of ________.
- A) just-in-time manufacturing
- B) facilities layout planning
- C) process planning
- D) location economies
Answer: D
AACSB: Analytical thinking
Skill: Application
Difficulty: Hard
LO: 15.1: Describe the elements to consider when formulating production strategies.
23) The process of assessing a company's ability to produce enough output to satisfy market demand is called process planning.
Answer: FALSE
AACSB: Application of knowledge
Skill: Concept
Difficulty: Easy
LO: 15.1: Describe the elements to consider when formulating production strategies.
24) Capacity planning applies only to manufacturing companies.
Answer: FALSE
AACSB: Application of knowledge
Skill: Concept
Difficulty: Moderate
LO: 15.1: Describe the elements to consider when formulating production strategies.
25) Availability of energy is an important aspect of the business environment necessary for facilities location planning.
Answer: TRUE
AACSB: Application of knowledge
Skill: Concept
Difficulty: Easy
LO: 15.1: Describe the elements to consider when formulating production strategies.
26) Worker productivity tends to be lower in most developing nations than in developed nations.
Answer: TRUE
AACSB: Application of knowledge
Skill: Concept
Difficulty: Moderate
LO: 15.1: Describe the elements to consider when formulating production strategies.
27) Transportation costs are a driving force behind the globalization of the steel industry.
Answer: TRUE
AACSB: Application of knowledge
Skill: Concept
Difficulty: Easy
LO: 15.1: Describe the elements to consider when formulating production strategies.
28) Companies selling differentiated products find centralized production most effective.
Answer: FALSE
Skill: Concept
Difficulty: Moderate
LO: 15.1: Describe the elements to consider when formulating production strategies.
29) It is important for low-cost competitors to locate near their markets in order to keep track of buyer preferences.
Answer: FALSE
Skill: Concept
Difficulty: Moderate
LO: 15.1: Describe the elements to consider when formulating production strategies.
30) The particular process to be used to create products is typically determined by a firm's business-level strategy.
Answer: TRUE
AACSB: Application of knowledge
Skill: Concept
Difficulty: Moderate
LO: 15.1: Describe the elements to consider when formulating production strategies.
31) Availability and cost of labor in the local market is crucial to process planning.
Answer: TRUE
AACSB: Application of knowledge
Skill: Concept
Difficulty: Easy
LO: 15.1: Describe the elements to consider when formulating production strategies.
32) The process by which a company extends its control over additional stages of production is called vertical integration.
Answer: TRUE
AACSB: Application of knowledge
Skill: Concept
Difficulty: Easy
LO: 15.1: Describe the elements to consider when formulating production strategies.
33) Companies strive toward quality improvements for attaining economies of scale.
Answer: FALSE
AACSB: Application of knowledge
Skill: Concept
Difficulty: Moderate
LO: 15.1: Describe the elements to consider when formulating production strategies.
34) Explain the process of facilities location planning. What issues must companies consider while selecting the location for their production facilities?
Answer: Selecting the location for production facilities is called facilities location planning. Companies often have many potential locations around the world from which to choose a site for production, research and development, or some other activity. Aspects of the business environment that are important to facilities location planning include the cost and availability of labor and management, raw materials, component parts, and energy. Other key factors include political stability, the extent of regulation and bureaucracy, economic development, and the local culture, including beliefs about work and important traditions.
Reducing production costs by taking advantage of lower wages in another country is often essential to keeping a company's products competitively priced. This is especially important when the cost of labor contributes greatly to total production costs. But the lower wages of a nation's workforce must be balanced against its potentially lower productivity. Worker productivity tends to be lower in most developing nations and some emerging markets as compared with developed nations.
Although most service companies must locate near their customers, they must still consider a wide variety of customers' needs when locating facilities.
Supply issues are also important in location planning. For any one mode of transportation, the greater the distance between production facilities and target markets, the longer it takes for customers to receive shipments. In turn, companies must compensate for delays by maintaining larger inventories in target markets–adding to storage and insurance costs. Shipping costs are also greater when production occurs away from target markets. Transportation costs are one of the driving forces behind the globalization of the steel industry. By building steel mills in countries where their customers are located, steel producers significantly reduce their transportation costs.
AACSB: Application of knowledge
Skill: Concept
Difficulty: Moderate
LO: 15.1: Describe the elements to consider when formulating production strategies.
35) How is process planning affected by a company's business-level strategy? How can outsourcing lower risk for firms?
Answer: Deciding on the process that a company will use to create its product is called process planning. The particular process to be used is typically determined by a firm's business-level strategy. For example, low-cost strategies normally require large-scale production because producers want the cost savings generated by economies of scale. A company that mass-produces snowboards for average skiers will typically use a highly automated production process that integrates advanced computer technology. Differentiation strategies, however, demand that producers provide extra value by offering customers something unique, such as superior quality, added features, or special brand images. Companies that handcraft snowboards for professionals will rely not on automated production but on skilled craftspeople. The company will design and produce each snowboard to suit the habits and special needs of each individual snowboarder. For such a company, service is a major component of the production process.
Availability and cost of labor in the local market is crucial to process planning. If labor in the host country is relatively cheap, an international company will likely opt for less technology and more labor-intensive methods in the production process–depending on its particular product and strategy. But again, the availability of labor and the level of wages in the local market must be balanced against the productivity of the local workforce.
The practice of buying from another company a good or service that is part of a company's value-added activities is called outsourcing. Outsourcing results from continuous specialization and technological advancement. For each successive specialization of its operations process, a manufacturer requires greater skill and knowledge than it did before. By outsourcing, a company can reduce the degree to which it is vertically integrated and the overall amount of specialized skills and knowledge that it must possess.
Many companies buy when buying is the lower-cost option. When a firm cannot integrate vertically by manufacturing a product for less than a supplier can, it will typically outsource.
One way a company can eliminate the exposure of assets to political risk in other countries is simply by refusing to invest in plants and equipment abroad. It can instead purchase products from international suppliers. This policy also eliminates the need to purchase expensive insurance coverage that is needed when a company undertakes production in an unstable country. Yet this policy will not completely shield the buyer from all potential disruptions–political instability can cause delays in the timely receipt of needed parts. Indeed, even under normal circumstances, the longer delivery times involved in international outsourcing can increase the risk that the buyer will not meet its own production schedule.
AACSB: Application of knowledge
Skill: Synthesis
Difficulty: Hard
LO: 15.1: Describe the elements to consider when formulating production strategies.
36) Describe the production managers' decision regarding whether to centralize or decentralize production facilities, and explain the benefits of vertical integration.
Answer: An important consideration for production managers is whether to centralize or decentralize production facilities. Centralized production refers to the concentration of production facilities in one location. With decentralized production, facilities are spread over several locations and could even mean having one facility for each national business environment in which the company markets its products–a common policy for companies that follow a multinational strategy. Companies often centralize production facilities in pursuit of low-cost strategies and to take advantage of economies of scale–a typical policy for companies that follow a global strategy. By producing large quantities of identical products in one location, the companies cut costs by reducing the per-unit cost of production.
Transportation costs and the physical landscape also affect the centralization versus decentralization decision. Because they usually sell undifferentiated products in all their markets, low-cost competitors generally do not need to locate near their markets in order to stay on top of changes in buyer preferences. That is why low-cost producers often choose locations with the lowest combined production and transportation costs. But even these firms must balance the cost of getting inputs into the production process and the cost of getting products to markets. Key factors in the physical environment that affect the transport of goods are the availability of seaports, airports, or other transportation hubs.
Conversely, companies that sell differentiated products may find decentralized production the better option. By locating separate facilities near different markets, they remain in close contact with customers and can respond quickly to changing buyer preferences. Closer contact with customers also helps firms develop a deeper understanding of buyer behavior in local cultures.
When close cooperation between research and development and manufacturing is essential for effective differentiation, both activities are usually conducted in the same place. Yet new technologies are giving companies more freedom to separate these activities. The rapid speed of communications today allows a subsidiary and its home office to be large distances from each other.
Vertical integration is the process by which a company extends its control over additional stages of production–either inputs or outputs. When a company decides to make a product rather than buy it, it engages in "upstream" activities (production activities that come before a company's current business operations). For example, a carmaker that decides to manufacture its own window glass is engaging in a new upstream activity.
Lower Costs-Above all, companies make products rather than buy them in order to reduce total costs. Generally speaking, the manufacturer's profit is the difference between the product's selling price and its production cost. When a company buys a product, it rewards the manufacturer by contributing to the latter's profit margin. Yet a company often undertakes in-house production when it can manufacture a product for less than it must pay another business to produce it. Thus in-house production allows a company to lower its own production costs. Small companies are less likely than large ones to make rather than buy, especially when a product requires a large financial investment in equipment and facilities. But this rule of thumb might not necessarily hold if the company possesses a proprietary technology or some other competitive advantage that is not easily copied.
Greater Control-Companies that depend on others for key ingredients or components give up a degree of control. Making rather than buying can give managers greater control over raw materials, product design, and the production process itself–all of which are important factors in product quality. In turn, quality control is especially important when customers are highly sensitive to even slight declines in quality or company reputation.
In addition, persuading an outside supplier to make significant modifications to quality or features can be difficult. This is especially true if modifications entail investment in costly equipment or if they promise to be time-consuming. If just one buyer requests costly product adaptations or if there is reason to suspect that a buyer will eventually take its business elsewhere, a supplier may be reluctant to undertake a costly investment. Unless that buyer purchases in large volumes, the cost of the modifications may be too great for the supplier to absorb. In such a case, the buyer simply may be unable to obtain the product it wants without manufacturing it in-house. Thus companies maintain greater control over product design and product features if they manufacture components themselves.
Finally, making a product can be a good idea when buying from a supplier means providing the supplier with a firm's key technology. Through licensing agreements companies often provide suppliers in low-wage countries with the technologies needed to make their products. But if a company's competitive advantage depends on that technology, the licensor could inadvertently be creating a future competitor. When controlling a key technology is paramount, it is often better to manufacture in-house.
AACSB: Application of knowledge
Skill: Synthesis
Difficulty: Hard
LO: 15.1: Describe the elements to consider when formulating production strategies.
37) Discuss the standardization versus adaptation decision for managers when considering production facilities, and describe considerations for managers when acquiring fixed assets.
Answer: An important issue in production strategy is deciding whether the production process will be standardized for all markets or adapted to manufacture products modified for different markets. For example, low-cost leadership often dictates automated, standardized production in large batches. Large production batches reduce the cost of producing each unit, thus offsetting the higher initial investment in automation. And production costs are reduced further as employees improve performance by repeating their activities and learning new procedures that would, for example, help minimize errors and waste.
But differentiation often demands decentralized facilities designed to improve local responsiveness. Because decentralized production facilities produce for one national market or for a regional market, they tend to be smaller. This tends to eliminate the potential to take advantage of economies of scale and therefore increases per-unit production costs. Similarly, the smaller market share that a differentiation strategy targets normally requires relatively smaller-scale production. Differentiating a product by incorporating certain features desired by customers requires more costly manufacturing processes. Research and development costs also tend to be higher for products with special product designs, styles, and features.
Most companies must acquire fixed (tangible) assets–such as production facilities, inventory warehouses, retail outlets, and production and office equipment–in the host country. Many companies have the option of either (1) acquiring or modifying existing factories or (2) building entirely new facilities–called a greenfield investment. Considering either option involves many individuals within the company. For example, production managers must verify that an existing facility (or an empty lot) is large enough and will suit the company's facility layout needs. Site acquisition experts and legal staff must guarantee that the proposed business activity abides by local laws. Public relations staff must work with community leaders to ensure that the company does not jeopardize the rights, values, and customs of the local population.
Finally, managers must make sure that the local infrastructure can support the firm's proposed on-site business operations. Also, factory and office equipment is likely to be available locally in most newly industrialized and developed markets, but not in developing markets. Thus managers must assess both the cost in tariffs that will be imposed on imported equipment and the cost in time and effort that will be required to import it.
AACSB: Application of knowledge
Skill: Synthesis
Difficulty: Hard
LO: 15.1: Describe the elements to consider when formulating production strategies.
38) The process by which a company extends its control over additional stages of production is called ________.
- A) a push strategy
- B) a pull strategy
- C) vertical integration
- D) horizontal integration
Answer: C
Skill: Concept
Difficulty: Easy
LO: 15.2: Outline the issues to consider when acquiring physical resources.
39) Which of the following reasons encourages companies to make a product rather than buy it?
- A) Making a product gives managers greater control over the production process.
- B) Making a product lowers the risk associated with the production process.
- C) Making a product increases the company's flexibility to respond to market conditions.
- D) Making a product gives companies a great deal of power in their relationships with suppliers.
Answer: A
Skill: Concept
Difficulty: Moderate
LO: 15.2: Outline the issues to consider when acquiring physical resources.
40) Which of the following reasons encourages companies to buy a product rather than make it?
- A) Buying a product gives managers greater control over the production process.
- B) Buying a product decreases the company's total costs significantly compared to making the product in-house.
- C) Buying a product ensures non-flexibility to local market conditions.
- D) Buying a product enables a company to gain a great deal of power in their relationships with suppliers.
Answer: D
Skill: Concept
Difficulty: Moderate
LO: 15.2: Outline the issues to consider when acquiring physical resources.
41) Which of the following processes will a computer assembling firm engage in if it decides to manufacture its own monitors and printers?
- A) outsourcing
- B) vertical integration
- C) niche marketing
- D) lean production
Answer: B
AACSB: Analytical thinking
Skill: Application
Difficulty: Hard
LO: 15.2: Outline the issues to consider when acquiring physical resources.
42) A firm that buys from another company a good or service that is part of the firm's value-added activities is practicing ________.
- A) outsourcing
- B) vertical integration
- C) horizontal integration
- D) lean production
Answer: A
Skill: Concept
Difficulty: Easy
LO: 15.2: Outline the issues to consider when acquiring physical resources.
43) ________ will enable a company to reduce the degree to which it is vertically integrated and the overall amount of specialized skills and knowledge that it would have to possess.
- A) Outsourcing
- B) Skimming
- C) Lean production
- D) Centralized production
Answer: A
Skill: Concept
Difficulty: Easy
LO: 15.2: Outline the issues to consider when acquiring physical resources.
44) Which of the following statements is true of outsourcing?
- A) It reduces economic risk by facilitating the purchase of large insurance policies.
- B) It reduces production risk by eliminating delays in the timely receipt of needed parts.
- C) It reduces political risk by enabling the company to avoid investing in plants and equipment abroad.
- D) It reduces currency risk by allowing the company to invest the home currency on in-house production facilities.
Answer: C
Skill: Concept
Difficulty: Moderate
LO: 15.2: Outline the issues to consider when acquiring physical resources.
45) Computer companies buying hardware components from component-makers, assembling them in their own facilities, and selling completed systems to consumers and businesses is an example of ________.
- A) telecommuting
- B) franchising
- C) outsourcing
- D) licensing
Answer: C
AACSB: Analytical thinking
Skill: Application
Difficulty: Hard
LO: 15.2: Outline the issues to consider when acquiring physical resources.
46) Which of the following is experienced by a company that outsources its product development?
- A) reduced investments in research and development
- B) reduced market flexibility
- C) less market influence with suppliers
- D) lower product costs due to the elimination of intermediaries
Answer: A
Skill: Concept
Difficulty: Moderate
LO: 15.2: Outline the issues to consider when acquiring physical resources.
47) ________ in the computer industry is the outsourcing of the actual assembly of computers plus the job of shipping them to distributors and other intermediaries.
- A) Agile manufacturing
- B) Just in time manufacturing
- C) Lean manufacturing
- D) Stealth manufacturing
Answer: D
Skill: Concept
Difficulty: Easy
LO: 15.2: Outline the issues to consider when acquiring physical resources.
48) Storage facilities, retail outlets, and production equipment are examples of ________.
- A) liquid assets
- B) current assets
- C) fixed assets
- D) intangible assets
Answer: C
Skill: Concept
Difficulty: Easy
LO: 15.2: Outline the issues to consider when acquiring physical resources.
49) A fixed asset can also be referred to as a ________ asset.
- A) liquid
- B) current
- C) tangible
- D) trading account
Answer: C
Skill: Concept
Difficulty: Easy
LO: 15.2: Outline the issues to consider when acquiring physical resources.
50) Which of the following is a barrier to buying products from international suppliers?
- A) extremely low tariffs
- B) additional transportation costs
- C) lower flexibility to respond to market conditions
- D) high political risk
Answer: B
AACSB: Application of knowledge
Skill: Concept
Difficulty: Moderate
LO: 15.2: Outline the issues to consider when acquiring physical resources.
51) Which of the following is established by a company that builds an entirely new facility?
- A) a divestiture
- B) a shadow economy
- C) a greenfield investment
- D) a shell corporation
Answer: C
Skill: Concept
Difficulty: Easy
LO: 15.2: Outline the issues to consider when acquiring physical resources.
Scenario: Hafstrom Motors
Based in Kentucky, Hafstrom Motors has always used spare parts made in America for its automobiles. However, sales and profits have slumped over the past three years. A senior manager at the company comes up with new strategies for improving the firm's production activities.
52) The top management of the company contends that Hafstrom would benefit most from manufacturing its own parts, rather than sourcing it from elsewhere, even if they are made at another location overseas. Which of the following is being recommended in this approach?
- A) just-in-time manufacturing
- B) location economies
- C) vertical integration
- D) outsourcing
Answer: C
AACSB: Analytical thinking
Skill: Application
Difficulty: Hard
LO: 15.2: Outline the issues to consider when acquiring physical resources.
53) The senior manager argues that Hafstrom could reduce its costs significantly by purchasing parts from companies located overseas rather than producing its own parts. Which of the following is the senior manager advocating?
- A) outsourcing
- B) a greenfield investment
- C) lean production
- D) vertical integration
Answer: A
AACSB: Analytical thinking
Skill: Application
Difficulty: Hard
LO: 15.2: Outline the issues to consider when acquiring physical resources.
Scenario: Audio Component Outsourcing
Echo Corporation manufactures high-quality audio components, such as speakers, amplifiers, and receivers, for home entertainment systems. Echo has been losing market share in recent years due to the competitive pricing of other audio component manufacturers that engage in outsourcing. Echo managers are attempting to convince Nathan Douglas, the firm's founder and CEO, that outsourcing would enable the firm to be more competitive without sacrificing quality.
54) Which of the following most likely supports the argument of Echo managers to outsource some of the firm's manufacturing activities?
- A) Echo managers could reduce the wages of U.S. based employees and sub-contractors.
- B) Echo could save money by reducing the costs incurred in manufacturing the component parts.
- C) Echo managers could implement a marketing campaign for foreign markets that is identical to the outsourced firm's marketing campaign.
- D) Echo could merge with one of its U.S.-based competitors to gain a larger market share.
Answer: B
AACSB: Reflective thinking
Skill: Critical Thinking
Difficulty: Hard
LO: 15.2: Outline the issues to consider when acquiring physical resources.
55) Which of the following should most likely be considered in making the decision to outsource some of Echo's manufacturing activities?
- A) Do purchasing components present the lowest cost option for Echo?
- B) Would Echo engineers be willing to relocate to a foreign nation?
- C) Is Echo prepared to cover moving expenses for its managerial talent?
- D) Can Echo find employees for a customer service center in the U.S.?
Answer: A
AACSB: Reflective thinking
Skill: Critical Thinking
Difficulty: Hard
LO: 15.2: Outline the issues to consider when acquiring physical resources.
56) Companies make products rather than buy them in order to reduce total costs.
Answer: TRUE
AACSB: Application of knowledge
Skill: Concept
Difficulty: Easy
LO: 15.2: Outline the issues to consider when acquiring physical resources.
57) A company often undertakes in-house production when it can manufacture a product for less than it must pay another business to produce it.
Answer: TRUE
AACSB: Application of knowledge
Skill: Concept
Difficulty: Easy
LO: 15.2: Outline the issues to consider when acquiring physical resources.
58) Today, due to improved technology, it is fairly easy to persuade an outside supplier to make significant modifications to a component.
Answer: FALSE
AACSB: Application of knowledge
Skill: Concept
Difficulty: Moderate
LO: 15.2: Outline the issues to consider when acquiring physical resources.
59) Outsourcing refers to the practice of buying from another company a good or a service that is part of a company's value-added activities.
Answer: TRUE
AACSB: Application of knowledge
Skill: Concept
Difficulty: Easy
LO: 15.2: Outline the issues to consider when acquiring physical resources.
60) One reason to buy a product instead of making it in-house is the greater flexibility to respond to market conditions.
Answer: TRUE
AACSB: Application of knowledge
Skill: Concept
Difficulty: Moderate
LO: 15.2: Outline the issues to consider when acquiring physical resources.
61) Total quality management reduces the responsibility on each individual in the production process.
Answer: FALSE
Skill: Concept
Difficulty: Easy
LO: 15.2: Outline the issues to consider when acquiring physical resources.
62) What role does flexibility play in the make-or-buy decision?
Answer: The typical manufacturing company requires a wide range of inputs into its production process. These inputs typically enter the production line either as raw materials that require processing or as components needing only assembly. A component may require minor adjustments or other minor processing before it goes into production. Deciding whether to make a component or to buy it from another company is called the make-or-buy decision.
Maintaining sufficient flexibility to respond to market conditions is increasingly important for companies everywhere. Making an in-house product that requires large investments in equipment and buildings often reduces flexibility. By contrast, companies that source products from one or more outside suppliers gain flexibility. In fact, added flexibility is the key factor in a fundamental change in attitude toward outsourcing, which many managers now regard as a full-fledged strategy for change rather than a limited tactical tool for solving immediate problems.
Maintaining flexibility is important when the national business environments of suppliers are volatile. Buying from several suppliers, or establishing production facilities in more than one country, allows a company to outsource products from one location if instability erupts in another. The same is true during periods of great volatility in exchange rates. Exchange-rate movements can increase or decrease the cost of importing a product from a given country. By buying from multiple suppliers located in several countries, a company can maintain the flexibility needed to change sources and reduce the risk associated with sudden swings in exchange rates.
Companies also maintain operational flexibility simply by not having to invest in production facilities. Unencumbered by investment in costly production equipment and facilities, a firm can alter its product line very quickly. This capability is especially important for products with small production runs or those with highly uncertain potential. Furthermore, a company can obtain financial flexibility if its capital is not locked up in plants and equipment. It can then use excess financial capital to pursue other domestic or international opportunities. Outsourcing can also free a company from having to invest in research and development, and then earn a return on that investment.
AACSB: Application of knowledge
Skill: Concept
Difficulty: Moderate
LO: 15.2: Outline the issues to consider when acquiring physical resources.
63) Describe the issues involved in the decision of how a company acquires raw materials and fixed assets.
Answer: Raw Materials-Decisions about the selection and acquisition of raw materials are important to many different types of manufacturers. The twin issues of quantity and quality drive many of these decisions. First, some industries and companies rely almost exclusively on the quantity of locally available raw materials. This is most true for companies involved in mining, forestry, and fishing. There must be an adequate supply of iron ore, oil, lumber, or fish to justify the large financial investment required to build processing facilities.
Second, the quality of raw material has a huge influence on the quality of a company's end product. For instance, food-processing companies must examine the quality of the locally grown fruit, vegetables, grains, and any other ingredients. Beverage companies must assess the quality of the local water supply. Some markets may require large financial investments to build water-purifying facilities. Elsewhere (such as much of the Middle East), the only local water source may be seawater that must be desalinized.
Fixed Assets-Most companies must acquire fixed (tangible) assets–such as production facilities, inventory warehouses, retail outlets, and production and office equipment–in the host country. Many companies have the option of either (1) acquiring or modifying existing factories or (2) building entirely new facilities–called a greenfield investment. Considering either option involves many individuals within the company. For example, production managers must verify that an existing facility (or an empty lot) is large enough and will suit the company's facility layout needs. Site-acquisition experts and legal staff must guarantee that the proposed business activity abides by local laws. Public relations staff must work with community leaders to ensure that the company does not jeopardize the rights, values, and customs of the local population.
Finally, managers must make sure that the local infrastructure can support the firm's proposed on-site business operations. Also, factory and office equipment is likely to be available locally in most newly industrialized and developed markets, but not in developing markets. Thus managers must assess both the cost in tariffs that will be imposed on imported equipment and the cost in time and effort that will be required to import it.
AACSB: Application of knowledge
Skill: Concept
Difficulty: Moderate
LO: 15.2: Outline the issues to consider when acquiring physical resources.
64) Which of the following statements is true regarding the ISO 9000 standards?
- A) They specify details on how companies should develop its quality processes.
- B) The standards are applicable to Asia exclusively.
- C) ISO 9000 is a certification that companies get for their environment-friendly initiatives.
- D) The standards require each company to define and document its own quality processes.
Answer: D
AACSB: Application of knowledge
Skill: Concept
Difficulty: Moderate
LO: 15.3: Identify the key production matters that concern managers.
65) ________ is the term used to refer to a production technique in which inventory is kept to a minimum and inputs to the production process arrive exactly when they are needed.
- A) Just-in-time manufacturing
- B) Lean manufacturing
- C) Continuous production
- D) Flow production
Answer: A
Skill: Concept
Difficulty: Easy
LO: 15.3: Identify the key production matters that concern managers.
66) The just-in-time (JIT) manufacturing technique was originally developed in ________.
- A) the United States
- B) China
- C) Japan
- D) Germany
Answer: C
Skill: Concept
Difficulty: Easy
LO: 15.3: Identify the key production matters that concern managers.
67) Discuss why companies strive toward quality improvement and the two methods of doing so.
Answer: Companies strive toward quality improvement for two reasons: costs and customer value. First, quality products help keep production costs low because they reduce waste in valuable inputs, reduce the cost of retrieving defective products from buyers, and reduce the disposal costs that result from defective products. Second, some minimum level of acceptable quality is an aspect of nearly every product today. Even companies that produce low-cost products try to maintain or improve quality, as long as it does not erode their position in what is typically a price-competitive market or market segment. A company that succeeds in combining a low-cost position with a high-quality product can gain a tremendous competitive advantage in its market.
Improving quality is also important for a company that provides services–whether as its only product or in conjunction with the goods it manufactures and markets. Managing quality in services is complicated by the fact that a service is created and consumed at the same time. For this reason, the human interaction between an employee who delivers a service and the buyer is important to service quality. Still, activities that must be conducted prior to the actual delivery of a service are also important. For example, it is important that a restaurant be clean and have on hand the ingredients it needs to prepare the meals on its menu. Likewise, a bank can provide high-quality service only if employees arrive for work on time and interact professionally with customers.
Two movements that inspire the drive toward quality are total quality management and International Standards Organization (ISO) 9000 certification.
Total Quality Management-Company-wide commitment to meet or exceed customer expectations through continuous quality improvement efforts and processes is called total quality management (TQM). It also places a great deal of responsibility on each individual to be focused on the quality of his or her own output–regardless of whether the employee's activities are based in the factory, in administration, or in management.
By continuously improving the quality of its products, a company can differentiate itself from rivals and attract loyal customers. The TQM philosophy initially took hold in Japan, where electronics and automobile firms applied TQM techniques to reduce costs and thereby gain significant market share around the world through price competitiveness and a reputation for quality. It was not until U.S. and European companies lost a great deal of market share to their Japanese rivals that they embraced TQM principles.
ISO 9000-The International Standards Organization (ISO) 9000 is an international certification that companies get when they meet the highest quality standards in their industries. Firms in the European Union are leading the way in quality certification. But both European and non-European companies alike are working toward certification in order to ensure access to the European marketplace.
To become certified, companies must demonstrate the reliability and soundness of all business processes that affect the quality of their products. Many companies also seek ISO 9000 certification because of the message of quality that certification sends to prospective customers.
AACSB: Application of knowledge
Skill: Concept
Difficulty: Easy
LO: 15.3: Identify the key production matters that concern managers.
68) Which of the following statements is true regarding total quality management (TQM)?
- A) TQM emphasizes on a single effort at the start to improve the quality of its products.
- B) TQM largely increases the responsibility on each individual to focus on quality.
- C) TQM philosophy initially took hold in the U.S.
- D) TQM applies solely to an employee's activities based inside a factory.
Answer: B
Skill: Concept
Difficulty: Moderate
LO: 15.4: Explain the potential ways to finance business operations.
69) ________ requires each individual to be focused on the quality of his or her own output.
- A) Total quality management
- B) Quality-of-life index
- C) Integrated business planning
- D) Organizational restructuring
Answer: A
Skill: Concept
Difficulty: Easy
LO: 15.4: Explain the potential ways to finance business operations.
70) A company using just-in-time (JIT) manufacturing involves ________.
- A) increased availability of components in large inventories
- B) quicker detection of defective materials and components
- C) easier training of sales staff regarding product descriptions
- D) benefits stemming from combining several Japanese technologies
Answer: B
Skill: Concept
Difficulty: Easy
LO: 15.4: Explain the potential ways to finance business operations.
71) Which of the following would companies do in markets that require long payback periods?
- A) divest operations
- B) implement retrenchment strategies
- C) emphasize on decruitment
- D) reinvest profits
Answer: D
Skill: Concept
Difficulty: Easy
LO: 15.4: Explain the potential ways to finance business operations.
72) When a market is experiencing rapid growth, a company will ________.
- A) emphasize on decruitment
- B) divest its operations
- C) reinvest in its operations
- D) implement retrenchment strategies
Answer: C
Skill: Concept
Difficulty: Easy
LO: 15.4: Explain the potential ways to finance business operations.
73) A loan in which a parent company deposits money with a host-country bank, which then lends the money to a subsidiary located in the host country is called a ________.
- A) syndicated loan
- B) back-to-back loan
- C) mortgage loan
- D) title loan
Answer: B
AACSB: Application of knowledge
Skill: Concept
Difficulty: Easy
LO: 15.4: Explain the potential ways to finance business operations.
74) American Depository Receipts (ADRs) are ________.
- A) certificates that represent shares of stock in American companies
- B) dollar deposits made by foreign firms conducting business in the U.S.
- C) certificates that trade in the U.S. and represent shares of stock in a non-U.S. company
- D) currency deposits made in the U.S. by firms based in other countries
Answer: C
AACSB: Analytical thinking
Skill: Concept
Difficulty: Easy
LO: 15.4: Explain the potential ways to finance business operations.
75) ________ are traded in Luxembourg and London and represent a specific number of shares in an outside company.
- A) Common stock
- B) Bills of lading
- C) Revocable letters of credit
- D) Global Depository Receipts
Answer: D
AACSB: Application of knowledge
Skill: Concept
Difficulty: Easy
LO: 15.4: Explain the potential ways to finance business operations.
76) Which of the following is true of American Depository Receipts (ADRs)?
- A) Investors who buy ADRs have to pay a currency-conversion fee.
- B) There is a minimum purchase requirement for ADRs.
- C) Companies offer ADRs in the U.S. to appeal to mutual funds.
- D) ADRs are listed and traded in London and Luxembourg.
Answer: C
Skill: Concept
Difficulty: Moderate
LO: 15.4: Explain the potential ways to finance business operations.
77) ________ is the financing obtained from investors who believe the borrower will experience rapid growth and who receive equity in return for their investment.
- A) Internal funding
- B) Venture capital
- C) Credit derivative
- D) Mortgage loan
Answer: B
Skill: Concept
Difficulty: Easy
LO: 15.4: Explain the potential ways to finance business operations.
78) Which of the following types of money adds to the volatility of emerging markets because it can be quickly withdrawn from its investment?
- A) hot money
- B) patient money
- C) key money
- D) fiat money
Answer: A
Skill: Concept
Difficulty: Easy
LO: 15.4: Explain the potential ways to finance business operations.
79) ________ refers to the foreign direct investment in factories, equipment, and land that cannot be pulled out of the market quickly.
- A) Hot money
- B) Patient money
- C) Fiat money
- D) Key money
Answer: B
AACSB: Application of knowledge
Skill: Concept
Difficulty: Easy
LO: 15.4: Explain the potential ways to finance business operations.
80) Money earned from the sale of goods and services is known as ________.
- A) revenue
- B) dividend
- C) depreciation
- D) book value
Answer: A
AACSB: Analytical thinking
Skill: Concept
Difficulty: Easy
LO: 15.4: Explain the potential ways to finance business operations.
81) The ________ of a company is the mix of equity, debt, and internally generated funds that it uses to finance its activities.
- A) enterprise value
- B) stock value
- C) capital structure
- D) corporate structure
Answer: C
AACSB: Analytical thinking
Skill: Concept
Difficulty: Easy
LO: 15.4: Explain the potential ways to finance business operations.
82) ________ appeals to companies because it lowers the amount of taxes the companies must pay.
- A) Debt
- B) Equity
- C) Stock value
- D) Enterprise value
Answer: A
AACSB: Analytical thinking
Skill: Concept
Difficulty: Easy
LO: 15.4: Explain the potential ways to finance business operations.
Scenario: Audio Component Outsourcing
Echo Corporation manufactures high-quality audio components, such as speakers, amplifiers, and receivers, for home entertainment systems. Echo has been losing market share in recent years due to the competitive pricing of other audio component manufacturers that engage in outsourcing. Echo managers are attempting to convince Nathan Douglas, the firm's founder and CEO, that outsourcing would enable the firm to be more competitive without sacrificing quality.
83) Which of the following is most likely a potential benefit for Echo if it outsources some of its manufacturing activities?
- A) heightened communications awareness
- B) increased activity in e-commerce sales
- C) strong intellectual property protection
- D) eliminating the exposure of assets to political risk
Answer: D
AACSB: Analytical thinking
Skill: Application
Difficulty: Hard
LO: 15.4: Explain the potential ways to finance business operations.
Scenario: Verandas International
Verandas International is expanding its operations in North America. The Dutch company supplies customized furniture to five-star hotels. Verandas International is a leader in this industry, but the company believes it must increase its geographic reach to maintain that position.
84) Economic forecasts reveal that the U.S. dollar is expected to decline relative to the Euro. Which of the following is the most advantageous method of obtaining funding for Verandas under these conditions?
- A) borrowing from U.S. banks
- B) issuing equity in Germany
- C) issuing equity in the U.S.
- D) borrowing from Dutch banks
Answer: A
AACSB: Analytical thinking
Skill: Application
Difficulty: Hard
LO: 15.4: Explain the potential ways to finance business operations.
85) The Verandas U.S. subsidiary was turned down when it tried to borrow from a U.S. bank. The bank manager suggested that the parent firm deposit money with the U.S. bank's Dutch branch, and then the U.S. bank's home office would lend the money to the U.S. subsidiary. This type of arrangement is known as a(n) ________.
- A) mortgage loan
- B) title loan
- C) back-to-back loan
- D) syndicated loan
Answer: C
AACSB: Analytical thinking
Skill: Application
Difficulty: Hard
LO: 15.4: Explain the potential ways to finance business operations.
86) If Verandas International chooses to pursue equity financing, but wants to avoid the time and money required to comply with stock exchange regulations, the company would most likely issue ________.
- A) American Depository Receipts
- B) bills of lading
- C) equity shares
- D) irrevocable letters of credit
Answer: A
AACSB: Analytical thinking
Skill: Application
Difficulty: Easy
LO: 15.4: Explain the potential ways to finance business operations.
87) The ISO 9000 is a production technique in which inputs to the production process arrive exactly when they are needed.
Answer: FALSE
AACSB: Application of knowledge
Skill: Concept
Difficulty: Easy
LO: 15.4: Explain the potential ways to finance business operations.
88) Just-in-time manufacturing drastically reduces the costs associated with large inventories in the production process.
Answer: TRUE
AACSB: Application of knowledge
Skill: Concept
Difficulty: Easy
LO: 15.4: Explain the potential ways to finance business operations.
89) Companies usually decide to reinvest when a market is experiencing rapid growth.
Answer: TRUE
AACSB: Application of knowledge
Skill: Concept
Difficulty: Easy
LO: 15.4: Explain the potential ways to finance business operations.
90) A back-to-back loan is one in which a subsidiary acquires a loan from the same bank where its parent secured the first loan.
Answer: FALSE
Skill: Concept
Difficulty: Easy
LO: 15.4: Explain the potential ways to finance business operations.
91) A major disadvantage of American Depository Receipts (ADRs) is that investors who buy them must pay currency-conversion fees.
Answer: FALSE
Skill: Concept
Difficulty: Moderate
LO: 15.4: Explain the potential ways to finance business operations.
92) Venture capital is a source of equity financing for successful multinational companies.
Answer: FALSE
Skill: Concept
Difficulty: Easy
LO: 15.4: Explain the potential ways to finance business operations.
93) Patient money is the cash that can be quickly withdrawn from a market in times of crisis.
Answer: FALSE
Skill: Concept
Difficulty: Easy
LO: 15.4: Explain the potential ways to finance business operations.
94) Debt appeals to companies because it lowers the amount of taxes the companies must pay.
Answer: TRUE
AACSB: Application of knowledge
Skill: Concept
Difficulty: Moderate
LO: 15.4: Explain the potential ways to finance business operations.
95) Why might companies decide to reinvest, scale back, or divest local operations?
Answer: Companies maintain the current level of operations when no new opportunities are foreseen. Yet changing conditions in the competitive global marketplace often force managers to choose between reinvesting in operations and divesting them.
Companies often reinvest profits in markets that require long payback periods as long as the long-term outlook is good. This is often the case in developing countries and large emerging markets. For example, corruption, red tape, distribution problems, and a vague legal system present challenges for non-Chinese companies. But because long-term returns on their investments are expected, Western companies reinvest heavily in China despite what are sometimes uncertain short-term profits. Most of these companies invest in production facilities to take advantage of a low-cost labor pool and low-cost energy.
Companies scale back their international operations when it becomes apparent that making operations profitable will take longer than expected. Again, China serves as a good example. Some companies were lured to China by the possibilities for growth offered by 1.2 billion consumers; however, some had to scale back ambitions based on overly optimistic marketing plans.
Companies usually decide to reinvest when a market is experiencing rapid growth. Reinvestment can mean either expanding in the market itself or expanding in a location that serves the growing market. Investing in expanding markets is often an attractive option because potential new customers usually have not yet become loyal to the products of any one company or brand. It can be easier and less costly to attract customers in such markets than it is to gain a share of markets that are stagnant or contracting.
Yet problems in the political, social, or economic sphere can force a company either to reduce or eliminate operations altogether. Such problems are usually intertwined with one another. For example, in recent years some Western companies pulled their personnel out of Indonesia because of intense social unrest stemming directly from a combination of political problems (discontent with the nation's political leadership), economic difficulties, and terrorist attacks.
Finally, companies invest in the operations that offer the best return on their investments. That policy often means reducing or divesting operations in some markets, even though they may be profitable, in order to invest in more profitable opportunities elsewhere.
AACSB: Application of knowledge
Skill: Concept
Difficulty: Moderate
LO: 15.4: Explain the potential ways to finance business operations.
96) What are the options available to companies seeking financial resources?
Answer: Companies need financial resources to pay for a variety of operating expenses and new projects. They must buy raw materials and component products for manufacturing and assembly activities. At certain times, they need large sums of capital, whether for expanding production capacity or entering new geographic markets. But companies also need financing to pay for all sorts of activities in addition to those related to production. They must pay for training and development programs and compensate workers and managers. Businesses must pay advertising agencies for helping the company promote its goods and services. They must also make periodic interest payments to lenders and perhaps reward stockholders with dividends.
But all companies have a limited supply of resources at their disposal to invest in current operations or new endeavors. So where do companies obtain needed funds? Generally speaking, organizations obtain financial resources through one of three sources:
- Borrowing (debt)
- Issuing equity (stock ownership)
- Internal funding
AACSB: Application of knowledge
Skill: Concept
Difficulty: Moderate
LO: 15.4: Explain the potential ways to finance business operations.
97) What are the advantages of American Depository Receipts (ADRs)?
Answer: Companies gain several important advantages through American Depository Receipts (ADRs). First, investors who buy ADRs pay no currency-conversion fees. By contrast, if a U.S. investor were to purchase the shares of a non-U.S. company on another country's stock exchange, he or she would incur the expense of converting currencies. Avoiding such expenses, plus the added convenience of paying in dollars, encourages U.S. investors to buy ADRs. Second, there are no minimum purchase requirements for ADRs, as there sometimes are for shares of a company's stock.
Third, companies offer ADRs in the United States to appeal to mutual funds. Investment laws in the United States limit the amount of money that a mutual fund can invest in the shares of companies not registered on U.S. exchanges. U.S. mutual fund managers were forced to sell shares of German software producer SAP when they appreciated in price. Listing ADRs in the United States also allowed the company to reward employees with discounted shares of company stock–something that it could not have done otherwise because companies are barred from awarding shares in unregistered companies to employees in the United States.
AACSB: Application of knowledge
Skill: Concept
Difficulty: Moderate
LO: 15.4: Explain the potential ways to finance business operations.
98) How can companies use internal funding to finance ongoing international business activities?
Answer: Ongoing international business activities and new investments can also be financed internally, whether with funds supplied by the parent company or by its international subsidiaries.
Internal Equity, Debt, and Fees-Spinoff companies and new subsidiaries typically require a period of time before they become financially independent. During this period, they often obtain internal financing from parent companies.
Many international subsidiaries obtain financial capital by issuing equity, which as a rule is not publicly traded. In fact, equity is often purchased solely by the parent company, which obviously enjoys great influence over the subsidiary's decisions. If the subsidiary performs well, the parent earns a return from the appreciating share price that reflects the increased valuation of the company. If the subsidiary decides to pay stock dividends, the parent company can also earn a return in this way. Parent companies commonly lend money to international subsidiaries during the startup phase and when subsidiaries undertake large new investments. Conversely, subsidiaries with excess cash often lend money to parent or sister companies that need capital.
Revenue from Operations-Money earned from the sale of goods and services is called revenue. This source of capital is the lifeblood of international companies and their subsidiaries.
If a company is to succeed in the long term, it must at some point generate sufficient internal revenue to sustain day-to-day operations. At that point, outside financing is required only to expand operations or to survive lean periods–say, during seasonal sales fluctuations.
International companies and their subsidiaries also generate revenues internally through so-called transfer prices–prices charged for goods or services transferred among a company and its subsidiaries. Companies set subsidiaries' transfer prices high or low, according to their own goals. For instance, often they pursue transfer pricing aggressively when they wish to minimize taxes in a high-taxation country. Transfer pricing can be used if there are no national restrictions on the use of foreign exchange or on the repatriation of profits to home countries.
AACSB: Application of knowledge
Skill: Concept
Difficulty: Moderate
LO: 15.4: Explain the potential ways to finance business operations.
99) Explain the concept of capital structure as it applies to a company with international operations.
Answer: The capital structure of a company is the mix of equity, debt, and internally generated funds that it uses to finance its activities. Firms try to strike the right balance among financing methods to minimize risk and the cost of capital.
Debt requires periodic interest payments to creditors such as banks and bondholders. If the company defaults on interest payments, creditors can take the company to court to force it to pay–even forcing it into bankruptcy. On the other hand, in the case of equity, only holders of certain types of preferred stock (which companies issue sparingly) can force bankruptcy because of default. As a rule, then, companies do not want to carry too much debt in relation to equity that can increase their risk of insolvency. Debt still appeals to companies in many countries, however, because interest payments can be deducted from taxable earnings–thus lowering the amount of taxes the firm must pay.
The basic principles of capital structure do not vary from domestic to international companies. But research indicates that multinational firms have lower ratios of debt to equity than domestic firms. Some observers cite increased political risk, exchange-rate risk, and the number of opportunities available to multinationals as possible explanations for the difference. Others suggest that the debt-versus-equity option depends on a company's national culture. But this suggestion has come under fire because companies from all cultures want to reduce their cost of capital. Moreover, many large international companies generate revenue from a large number of countries.
National restrictions can influence the choice of capital structure. These restrictions include limits on the international flows of capital, the cost of local financing versus the cost of international financing, access to international financial markets, and controls imposed on the exchange of currencies. The choice of capital structure for each of a company's international subsidiaries–and, therefore, its own capital structure–is a highly complex decision.
AACSB: Application of knowledge
Skill: Concept
Difficulty: Moderate
LO: 15.4: Explain the potential ways to finance business operations.
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