Foreign Investment, Rates Of Return, Purchasing Power Parity

1. Why do U.S. corporations build manufacturing plants abroad when they could build them at home? Explain with information / data of real companies.

There are important reasons why U.S companies decide to invest in foreign countries. Among these we can be mentioned; Tax incentives: Developing countries tend to offer tax benefits to foreign investors in order to capture the interest of these to invest in their countries. This produces a greater flow of direct and indirect jobs. The fiscal costs in third world countries tend to be lower than in developed countries, so that large companies choose to invest where they have to pay less tax. Labor legislation in other countries is much more flexible. This leads to cheaper production costs. The use of cheap labor allows to investors to save resources that could be used in technological improvements. Cheap labor: Labor in the United States is much more expensive than abroad. Therefore, production in other countries, it is much more attractive to companies such as: Apple. Apple does not manufacture its devices in the United States. Apple prefers to produce their devices in countries like China. Although Apple would manufacture its devices in the United States, labor and materials are much more expensive in the U.S. than in China. For Apple to produce their devices at home, the company would have to invest 25 billion dollars, which represents almost 50% of total profits for an entire year. “By locating the same iPhone factory in America, Apple would add more than $25 billion in labor costs a year”

The main reason is because it is easier to master every aspect of the manufacture of the product abroad than in home. The industrial wage in the United States in 2010 was 17 times higher than the industrial wage in China. “The average manufacturing wage in 2010 is about $2.00 in China and $34.75 in America.” Nowadays, larges companies want to produce at the lower cost possible. It is a powerful competitive advantage that companies use to sell and achieve positioning on their products in every market where they compete.

2. Should firms require higher rates of return on foreign projects than on identical projects located at home? Explain.

The higher the risk, the higher the rate of return that a company should be receive. Multinational companies with investments overseas face many financial risks. When the investor perceives a high risk in an investment, he should be protected about it. Increased compensation by raising the rate of return, could be an appropriate way to protect the investment. Also, there is a direct relationship between inflation and market interest rate. A higher rate of inflation generate higher interest rate.

3. Why might purchasing power parity fail to hold?

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