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    Multinational Capital Budgeting: South-Western/Thomson Learning © 2003

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    Wi Silalahi

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    © All Rights Reserved
    Download as PPT, PDF, TXT or read online from Scribd

    Multinational Capital Budgeting: South-Western/Thomson Learning © 2003

    Uploaded by

    Wi Silalahi
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    © All Rights Reserved
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    Download as ppt, pdf, or txt
    18 views19 pages

    Multinational Capital Budgeting: South-Western/Thomson Learning © 2003

    Uploaded by

    Wi Silalahi

    Copyright:

    © All Rights Reserved
    Download as PPT, PDF, TXT or read online from Scribd
    Download as ppt, pdf, or txt
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    Chapter 14

    Multinational Capital Budgeting

    South-Western/Thomson Learning © 2003


    Chapter Objectives

    • To compare the capital budgeting analysis


    of an MNC’s 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.

    A14 - 2
    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.

    A14 - 3
    Subsidiary versus Parent
    Perspective
    The difference in cash inflows is 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
    A14 - 4
    Subsidiary versus Parent
    Perspective
    • A parent’s perspective is appropriate
    when evaluating a project, since any
    project that can create a positive net
    present value for the parent should
    enhance the firm’s value.
    • However, one exception to this rule may
    occur when the foreign subsidiary is not
    wholly owned by the parent.

    A14 - 5
    Input for Multinational
    Capital Budgeting
    The following forecasts are usually required:
    1.Initial investment
    2.Consumer demand
    3.Product price
    4.Variable cost
    5.Fixed cost
    6.Project lifetime
    7.Salvage (liquidation) value

    A14 - 6
    Input for Multinational
    Capital Budgeting
    The following forecasts are usually required:
    8.Fund-transfer restrictions
    9.Tax laws
    10.Exchange rates
    11.Required rate of return

    A14 - 7
    Multinational
    Capital Budgeting
    • Capital budgeting is necessary for all
    long-term projects that deserve
    consideration.
    • One common method of performing the
    analysis is to estimate the cash flows and
    salvage value to be received by the parent,
    and compute the net present value (NPV)
    of the project.

    A14 - 8
    Multinational
    Capital Budgeting
    • NPV = – initial outlay
    n
    +  cash flow in period
    t
    t
    t =1 (1 + k )

    +
    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.

    A14 - 9
    Capital Budgeting Analysis
    Period t
    1.Demand (1)
    2.Price per unit (2)
    3.Total revenue (1)(2)=(3)
    4.Variable cost per unit (4)
    5.Total variable cost (1)(4)=(5)
    6.Annual lease expense (6)
    7.Other fixed periodic expenses (7)
    8.Noncash expense (depreciation) (8)
    9.Total expenses (5)+(6)+(7)+(8)=(9)
    10. Before-tax earnings of subsidiary(3)–(9)=(10)
    11. Host government taxtax
    rate(10)=(11)
    12. After-tax earnings of subsidiary(10)–
    (11)=(12)

    A14 - 10
    Capital Budgeting Analysis
    Period t
    13. Net cash flow to subsidiary (12)+(8)=(13)
    14. Remittance to parent(14)
    15. Tax on remitted fundstax
    rate(14)=(15)
    16. Remittance after withheld tax(14)–(15)=(16)
    17. Salvage value(17)
    18. Exchange rate(18)
    19. Cash flow to parent
    (16)(18)+(17)(18)=(19)
    20. Investment by parent(20)
    21. Net cash flow to parent (19)–(20)=(21)
    22. PV of net cash flow to parent (1+k) - t(21)=(22)
    23. Cumulative NPVPVs=(23)

    A14 - 11
    Factors to Consider in
    Multinational Capital Budgeting
    Exchange rate fluctuations. Different
    scenarios should 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.

    A14 - 12
    Factors to Consider in
    Multinational Capital Budgeting
    Financing arrangement. Financing costs
    are usually captured by the discount rate.
    However, many foreign projects are
    partially financed by foreign subsidiaries.
    Blocked funds. Some countries may
    require that the earnings be reinvested
    locally for a certain period of time before
    they can be remitted to the parent.

    A14 - 13
    Factors to Consider in
    Multinational Capital Budgeting
    Uncertain salvage value. The salvage value
    typically has a significant impact on the
    project’s NPV, and 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 considered in the analysis.

    A14 - 14
    Adjusting Project Assessment
    for Risk
    • If an MNC is unsure of the cash flows of a
    proposed project, it needs to adjust its
    assessment for this risk.
    • One method is to use a risk-adjusted discount
    rate. The greater the uncertainty, the larger
    the discount rate that is applied.
    • Many computer software packages are also
    available to perform sensitivity analysis and
    simulation.

    A14 - 15
    Impact of Multinational Capital Budgeting
    on an MNC’s Value
    Multinational Capital Budgeting
    Decisions

    m 
    n 
     
    E CFj , t  E ER j , t  
     j 1 
    Value =   
    t =1  1  k  t

     

    E (CFj,t ) = expected cash flows in currency j to


    be received by the U.S. parent at the end of
    period t
    E (ERj,t ) = expected exchange rate at which
    currency j can be converted to dollars at the end
    A14 - 16
    Chapter Review

    • Subsidiary versus Parent Perspective


    ¤ Tax Differentials
    ¤ Restricted Remittances
    ¤ Excessive Remittances
    ¤ Exchange Rate Movements
    • Input for Multinational Capital Budgeting
    • Multinational Capital Budgeting

    A14 - 17
    Chapter Review

    • Factors to Consider in Multinational Capital


    Budgeting
    ¤ Exchange Rate Fluctuations
    ¤ Inflation
    ¤ Financing Arrangement
    ¤ Blocked Funds
    ¤ Uncertain Salvage Value
    ¤ Impact of Project on Prevailing Cash Flows
    ¤ Host Government Incentives

    A14 - 18
    Chapter Review

    • Adjusting Project Assessment for Risk


    ¤ Risk-Adjusted Discount Rate
    ¤ Sensitivity Analysis
    ¤ Simulation
    • Impact of Multinational Capital Budgeting
    on an MNC’s Value

    A14 - 19

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