The Elimination of the Hurdle

MMI has selected return on investment as the most important criterion for approving new projects. Along with that potentially disastrous strategy, the business has also arbitrarily set a goal of 15 percent for corporate and foreign affiliate performance on projects. As a result, the company tend not to engage in low-risk, low return projects, or high-risk, high return projects.

The reason that merely considering return on investment just isn't a wise decision for multinational companies is that it does not look at more factors which can be difficult to quantify. For example, a project could be regarded high risk by American standards, but low risk from the country exactly where it's being undertaken. Or, a low return project may well supply entrance into a industry in which returns on a lengthy period of time would be great. By focusing on short-term return, the company is limiting the alternatives that it can workout in terms of expanding its market, introducing new products and solutions and taking full advantage of its foreign operations.

Political and economic risks are difficult to quantify, as the manager cited in Part I noted, but they have to become accounted for if the business is to monitor and control its operations. Uncertainty is often a component of any enterprise, and multinational managers need to not be excused from factoring in uncertainty to their actions.

The executives on the foreign affiliate of Brazil cite the inflationary conditions that make local borrowing specifically advantageous in that country. The Mexican affiliate is required to participate in joint ventures and so sees reason for exception in his case. What both of these affiliates recognize is that they are in different environments that make probably the most debt/equity ratios for their operations various from each other and within the company like a whole.

If the multinational parent would allow the foreign affiliates to seek out probably the most capital structure for their environment, they would also be in a position to seek out the projects which maximize their return on investment whether the investment was obtained via equity or debt financing.

If foreign affiliates are encouraged to seek out the optimum debt/equity ratio for their environment, MMI's profitability will increase. Some affiliates will have greater than 35 percent debt/equity levels in nations in which that strategy makes sense, though other affiliates, in nations in which capital is expensive, will have lower levels. Corporate MMI will benefit from this strategy.

3. Capital structure also affects the rates of return on projects that the foreign affiliate undertakes. For example, a foreign affiliate that may be needed to maintain an arbitrarily set debt/equity ratio (such as MMI's affiliates) would be forced to hold an equally arbitrary required rate of return on its projects. Real returns on projects might be higher or lower depending on a actual cost of capital, but if the affiliate is efficiently prevented from pursuing probably the most attractive form of capital due to debt/equity requirements, it would be unable to consume advantage with the optimum mix of debt and equity.

 

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