We study the impact of FDI on domestic welfare using a model of internal trade with variable markups that incorporates intranational transport costs. The model allows us to disentangle the channels through which FDI affects welfare. We apply the model to the case of Ethiopian manufacturing, finding gains from the presence of foreign firms in the local market and other connected markets in the country. FDI resulted in a modest worsening of allocative efficiency because foreign firms have higher markups. We report consistent findings from our empirical analysis, using microdata on firms, FDI, and geospatial data on the road network.