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Multinational Capital Budgeting Insights

This document discusses multinational capital budgeting. It begins by outlining the chapter objectives of comparing analysis from a subsidiary and parent perspective, demonstrating how to determine if an international project should be implemented, and explaining how to assess international project risk. It then discusses factors to consider like tax rates, regulations on remitting funds, exchange rates, and exceptions when the subsidiary is not wholly owned. It provides key inputs needed for analysis and outlines the net present value method. Finally, it discusses additional factors to account for like exchange rate fluctuations, inflation, financing arrangements, blocked funds, salvage values, competition, government incentives, and real options. It also addresses adjusting projects for risk.

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Amna Nawaz
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54 views9 pages

Multinational Capital Budgeting Insights

This document discusses multinational capital budgeting. It begins by outlining the chapter objectives of comparing analysis from a subsidiary and parent perspective, demonstrating how to determine if an international project should be implemented, and explaining how to assess international project risk. It then discusses factors to consider like tax rates, regulations on remitting funds, exchange rates, and exceptions when the subsidiary is not wholly owned. It provides key inputs needed for analysis and outlines the net present value method. Finally, it discusses additional factors to account for like exchange rate fluctuations, inflation, financing arrangements, blocked funds, salvage values, competition, government incentives, and real options. It also addresses adjusting projects for risk.

Uploaded by

Amna Nawaz
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as DOC, PDF, TXT or read online on Scribd

Multinational Capital Budgeting

Chapter Objectives
To compare the capital budgeting analysis of an
MNCs subsidiary with that of its parent;
To demonstrate how multinational capital
budgeting can be applied to determine whether an
international project should be implemented; and
To explain how the risk of international projects
can be assessed.

Subsidiary versus Parent Perspective


Should the capital budgeting for a multi-national
project be conducted from the viewpoint of the
subsidiary that will administer the project, or the
parent that will provide most of the financing?
The results may vary with the perspective taken
because the net after-tax cash inflows to the parent
can differ substantially from those to the
subsidiary.
Such differences can be due to:

Tax differentials
What is the tax rate on remitted funds?

Regulations that restrict remittances

Excessive remittances
The parent may charge its subsidiary very high
administrative fees.

Exchange rate movements

Subsidiary versus Parent Perspective


A parents perspective is appropriate when
evaluating a project, since any project that can
create a positive net present value for the parent
should enhance the firms value.
However, one exception to this rule occurs when
the foreign subsidiary is not wholly owned by the
parent.

Input for Multinational Capital Budgeting

The following forecasts are usually required:


1.

Initial investment

2.

Consumer demand over time

3.

Product price over time

4.

Variable cost over time

5.

Fixed cost over time

6.

Project lifetime

7.

Salvage (liquidation) value

8.

Restrictions on fund transfers

9.

Tax payments and credits

10. Exchange rates


11. Required rate of return

Multinational Capital Budgeting


Capital budgeting is necessary for all long-term
projects that deserve consideration.

One common method of performing the analysis


involves estimating the cash flows and salvage
value to be received by the parent, and then
computing the net present value (NPV) of the
project.

Multinational Capital Budgeting

NPV

initial outlay
n
+ S cash flow in period t
t =1
(1 + k )t
+ salvage value
(1 + k )n

k = the required rate of return on the project


n = project lifetime in terms of periods
If NPV > 0, the project can be accepted.

Factors to Consider in Multinational Capital Budgeting


Exchange rate fluctuations
Since it is difficult to accurately forecast exchange
rates, different scenarios can be considered together
with their probability of occurrence.
Inflation
Although price/cost forecasting implicitly considers
inflation, inflation can be quite volatile from year to
year for some countries.
Financing arrangement
Financing costs are usually captured by the
discount rate.
However, when foreign projects are partially
financed by foreign subsidiaries, a more accurate
approach is to separate the subsidiary investment and
explicitly consider foreign loan payments as cash
outflows.

Factors to Consider in Multinational Capital Budgeting


Blocked funds
Some countries require that the earnings generated
by the subsidiary be reinvested locally for at least a
certain period of time before they can be remitted to the
parent.
Uncertain salvage value
Since the salvage value typically has a significant
impact on the projects NPV, the MNC may want to
compute the break-even salvage value.
Impact of project on prevailing cash flows
The new investment may compete with the existing
business for the same customers.
Host government incentives
These should also be incorporated into the analysis.
Real options
Some projects contain real options for additional
business opportunities.
The value of such a real option depends on the
probability of exercising the option and the resulting
NPV.

Adjusting Project Assessment for Risk


When an MNC is unsure of the estimated cash
flows of a proposed project, it needs to incorporate
an adjustment for this risk.
One method is to use a risk-adjusted discount rate.
The greater the uncertainty, the larger the discount
rate that should be applied to the cash flows.
An MNC may also perform sensitivity analysis or
simulation using computer software packages to
adjust its evaluation.
Sensitivity analysis involves considering alternative
estimates for the input variables, while simulation
involves repeating the analysis many times using
input values randomly drawn from their respective
probability distributions.

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