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Nestle, the Swiss foods conglomerate is as multinational as a company can be. About 98% of...

Nestle, the Swiss foods conglomerate is as multinational as a company can be. About 98% of its sales takes place oversea, and the group’s diversified operations span 150 countries. Nestle’s numerous (and generally wholly owned) subsidiaries are operationally decentralized. However, finances are centralized in Vevey, Switzerland. Staffed by only 12 people, the finance department makes all subsidiary funding decisions, manages the resulting currency exposures, determines subsidiary dividends amounts, sets the worldwide
debt/equity structure, and evaluates subsidiary performance.

Nestle’s centralized finance function plays the pivotal role in the firm’s intricate web of subsidiary-to-headquarters profit remittances and headquarters-to-subsidiary investment flows. Profits and excess cash are collected by the treasury department in Vevey and then channeled back to overseas subsidiaries in the form of equity and debt investments. Nestle considers this approach to be the best possible investment for the group’s wealth.

When a subsidiary is first established, its fixed assets – which form about half of the total investment – are financed by the Nestle group, generally with equity. Later on, the group may supply long-term debt as needed to support operations. The local subsidiary manager handles all the marketing and production decisions, but decisions regarding long-term debt and equity funding are managed solely by Vevey headquarters.

The other half of the investment – working capital – is then acquired locally, usually via bank credit or commercial paper. However, Nestle varies this general approach to suit each country. In certain countries – those that permit free transfers of funds – Nestle finances part of the working capital from Vevey instead of using local bank credits.

Central control over affiliate capital structures is facilitated by the policy of forcing local managers to dividend out almost 100% of their profits to Switzerland. The particular capital structure chosen for an affiliate depend son various considerations, including taxes, political risk, and currency risk.

To ensure that it borrows at the lowest possible cost, Nestle takes considerable care to structure its capital base to keep a top credit rating. The desire for a low-risk capital structure is also consistent with Nestle’s business strategy. According to Senior Vice President, Finance, Daniel Regolatti, “Our basic strategy is that what are an industrial company. We have a lot of risks in a lot of countries, so we should not add high financial risks.  

Required:

According to paragraph 2, why Nestle considers its approach is the best possible investment for the group’s wealth? Justify your answers relative to MNC’s cost of capital.


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Expert Solution

Hi there ,

The company having centrailised system for the purpose of lending long term debt creates more control over the subsidiary. It alows the susbsidiary to lower its costs such as interest. The company also issues equity in the local market inorder to lower its costs. As the amount raised internally shall have leverage over the external borrowings.

Having centralised system for major decision making such as creation fixed cost leads will be huge burden in the new market. Hence company giving for loans to subsidiary, which allows subsidiary to have better working capital. Hence the company can have better position to deal with new adversities.

The company clearly knows the each market to be different and requires different approach either in terms of capital or market penitration. Hence the core team shall make initial decisions as the initial costs are high and shall have major impact deciding the functioning. The company also considerably takes 100% dividend payout. This allows the top management to decide the further usage and market in which the company needs to invest more for the purpose of growth and increase the shareholders and companys wealth.  


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