FIN 355 Week 3 Capital Flows and Foreign Investment Example

Mexico or Costa Rica for a Catheter Plant? Why Capital Crosses Borders, the Eclectic Paradigm and a Discounted Comparison of Two Sites for a Composite Medical Device Maker

[Student Name]

University of Phoenix

FIN/355: International Finance and Trade

Week 3 Assignment

[Instructor Name]

[Date]

The device maker, the sites and all figures are composites written for a model paper; concepts and research findings come from the sources listed.

A composite company in Minnesota designs and makes catheters, extension sets and tubing for hospitals. Its US plant is at capacity, and wage and hiring pressures make a second US plant costly. The board has asked management to compare two sites for a new plant producing lower-complexity products: an industrial park near Tijuana, Mexico, and a free trade zone near San José, Costa Rica, both with established medical device clusters. Moving production abroad is not only a cost decision; it is a bet on a country's institutions, workforce and stability for the next fifteen years. This paper analyzes the choice.

Two Kinds of Capital Flow

International capital flows take two broad forms. Portfolio investment buys foreign stocks and bonds without control and can be withdrawn quickly when conditions change. Foreign direct investment creates or acquires a lasting controlling interest in a business abroad, such as a plant. The catheter plant is direct investment: capital tied to buildings, equipment and trained workers that cannot easily leave. Host countries generally welcome it more than volatile portfolio flows because it brings jobs, skills and exports (Krugman et al., 2022).

Why Own a Plant Abroad

Dunning (1988) explained foreign direct investment with three advantages. Ownership advantages are assets the firm has that local competitors lack; the company's advantages are its product designs, its quality system validated by the US Food and Drug Administration and its customer relationships. Location advantages are features of a country that make producing there attractive, such as labor, logistics and incentives. Internalization advantages explain why the firm owns the plant rather than licensing its technology to a local manufacturer; the company would risk losing control of proprietary processes and quality, which regulators hold it responsible for. All three point toward owning a plant abroad.

Comparing the Locations

Research on exporting firms shows that the companies that produce and sell abroad tend to be larger and more productive than others (Bernard et al., 2007), and the device maker fits that profile. Tijuana offers proximity: finished products can reach the company's distribution center in California by truck the same day, and managers can travel from Minnesota easily. Its medical device cluster includes more than 70 manufacturers, so experienced technicians and suppliers of molding and packaging are available. Wages are lower than in the United States, and the plant would operate under Mexico's program for export manufacturers, deferring import duties on materials. Risks include wage inflation in the cluster, security concerns and changes in trade policy.

Costa Rica offers a highly educated workforce, a strong reputation for medical device quality and free trade zone benefits, including exemption from income tax for a period and then a reduced rate, and duty-free import of materials. Its political stability has been high for decades. Its drawbacks are distance, with products shipping by air or sea, higher wages than in Tijuana and a smaller supplier base for some components.

Discounted Comparison

The company estimated each site's costs and cash flows over fifteen years for the same output. The Tijuana plant would cost $38 million and generate after-tax cash savings compared with US production of about $8.6 million a year; the Costa Rica plant would cost $41 million and generate about $8.9 million a year, helped by lower taxes but offset by higher freight. Management discounts at its 9% cost of capital plus a country risk premium: 2.5 points for Mexico, reflecting security and policy risk, and 1.5 points for Costa Rica. At 11.5%, the Tijuana plant's net present value is about $22 million; at 10.5%, Costa Rica's is about $25 million.

Beyond the Numbers

The results are close, and small changes in assumptions could reverse them. Tijuana's advantage in time to market matters for products with short lead times and custom orders, while Costa Rica's tax holiday is valuable but depends on maintaining export and employment commitments. The company's largest risk in Mexico is wage inflation in a tight labor market; in Costa Rica, it is logistics disruption.

Currency and Repatriation

The plant's costs will be incurred in pesos or colones, while its output is priced in dollars, so a stronger local currency would raise costs. The company plans to hedge a portion of local payroll for the first two years and to pay suppliers in dollars where possible. It also confirmed that both countries allow profits and capital to be returned to the United States without restriction, and it will structure intercompany pricing so the plant earns a routine return consistent with its functions, which tax authorities in both countries expect.

Effects on the Home Country

Moving production of lower-complexity products abroad raises concerns at home. The company will keep its Minnesota plant focused on complex, higher-margin products and new product introductions, and it expects to add engineering and quality jobs there as total volume grows. Management expects the expansion to add skilled roles at home even as it moves some production jobs in the affected product lines, and it has committed to retraining affected operators for complex lines.

Host Country Policy and Capital Flows

Both countries actively attract direct investment through free trade zones and export programs, and both are parties to trade agreements with the United States that allow duty-free export of qualifying goods. Policy can also restrict flows: some countries limit foreign ownership in certain sectors or impose capital controls on portfolio money during crises. The company's plant, by bringing long-term capital and skilled jobs, fits the kind of investment both countries seek.

Recommendation

The company should choose Costa Rica for the lower-complexity products, where time to market matters less and the risk-adjusted value is higher, and keep Tijuana as an option for a future plant making custom products that need quick delivery. It should negotiate its free trade zone agreement with clear terms for the tax holiday and plan air freight contracts to limit logistics risk.

Conclusion

The catheter plant is direct investment motivated by the company's ownership of designs and quality systems, the location advantages of two established clusters and the internalization advantage of controlling production. A discounted comparison with country risk premiums favored Costa Rica slightly, and strategic factors supported that choice for these products.

References

Bernard, A. B., Jensen, J. B., Redding, S. J., & Schott, P. K. (2007). Firms in international trade. Journal of Economic Perspectives, 21(3), 105-130. https://doi.org/10.1257/jep.21.3.105

Dunning, J. H. (1988). The eclectic paradigm of international production: A restatement and some possible extensions. Journal of International Business Studies, 19(1), 1-31. https://doi.org/10.1057/palgrave.jibs.8490372

Krugman, P. R., Obstfeld, M., & Melitz, M. J. (2022). International economics: Theory and policy (12th ed.). Pearson.