Multinational Capital Budgeting Quiz

Multinational Capital Budgeting

• Multinational capital budgeting involves evaluating investments in foreign subsidiaries.
• The process of capital budgeting for a foreign project uses the same theoretical framework as domestic capital budgeting.
• Key decisions in international projects are often strategic, behavioral, and economic, besides reinvestment decisions.
• These decisions need to be justified by traditional financial analysis.
• Multinational capital budgeting, like domestic capital budgeting, concentrates on cash inflows and outflows from long-term investment projects.
• Capital budgeting is needed for all worthy long-term projects.

Outline of Multinational Capital Budgeting

• Explain multinational capital budgeting.
• Compare capital budgeting analysis of an MNC's subsidiary and its parent.
• Show how multinational capital budgeting helps determine if an international project is viable.
• Explain how to assess the risks of international projects.

Steps in Multinational Capital Budgeting

• Identify the initial capital invested or at risk.
• Estimate project cash flows over time, including terminal/salvage value.
• Determine the appropriate discount rate.
• Use traditional criteria like NPV, IRR, and payback period.

Multinational Capital Budgeting (3)

• Foreign project analysis is more intricate than domestic.
• Distinguish parent/subsidiary cash flows from project cash flows.
• Parent/subsidiary cash flows depend on the financing structure.
• Cash flows generated by an investment in one subsidiary can sometimes affect another.
• Exchange rates, taxes, and remittances significantly affect cash flow projections.

Subsidiary vs. Parent Perspective

• Should multinational project budgeting be from the subsidiary or parent's perspective?
• Perspective affects calculations because net after-tax cash flow to the parent can differ substantially from that of the subsidiary.
• This is due to factors like tax differences, remittance restrictions, high administrative fees, and exchange rate fluctuations.

Subsidiary vs. Parent Perspective (2)

• Differences in project valuations are due to:
• Tax differentials.
• Regulations restricting remittances and the tax rate on remitted funds.
• Excessive remittances demanding high administrative fees.
• Exchange rate fluctuations impact cash flows.

Subsidiary vs. Parent Perspective (3)

• Managers should evaluate country risk influencing discount rates, impacting expected cash flows.
• Political, macroeconomic, and other events can drastically reduce cash flow value or availability.
• Country risk premiums affect discount rates.
• Terminal values are difficult to estimate when considering various potential purchases from multiple parties (host, parent, etc.).
• Different perspectives on project value can exist.

Remitting Subsidiary Earnings to the Parent

• Cash flows are generated in the subsidiary.
• After-tax cash flows go to the subsidiary.
• Cash is remitted by the subsidiary.
• After-tax cash flows from remittances are converted to the parent's currency.

Project vs. Parent Valuation

• Analyzing a foreign project from a parent's viewpoint is justified; parent's projects positively impact firm value.
• Exceptions exist when the subsidiary isn't wholly owned by the parent.
• A local project should provide at least the risk-free return obtained from host government bonds with the same maturity as the project's economic life.

###Project vs. Parent Valuation (2)

• Many firms evaluate foreign projects from both parent and subsidiary viewpoints to understand the project's NPV impact on the company's overall earnings.
• Two methods to view the issue exist: centralized and decentralized capital budgeting.

###Project vs. Parent Valuation (3)

• Methods focus on nominal cash flows, exchange rates, and expected costs of capital for local and parent currencies.
• Methods start by estimating the project's local currency cash flows.
• Long-term projections consider competitive and market advantages.
• Estimated cash flows must exclude tax payments.

Decentralized Capital Budgeting

• Forecast cash flows in the local currency.
• Discount those cash flows using the foreign cost of capital.
• Convert the NPV to the parent's home currency using the spot exchange rate.

Centralized Capital Budgeting

• Forecast cash flows in the local currency.
• Convert these cash flows into the parent's home currency using expected annual exchange rates.
• Discount using the domestic cost of capital to account for the parent's currency.

Centralized vs. Decentralized

• Firms typically evaluate foreign investments from both parent and subsidiary viewpoints and consider the combined impact on consolidated earnings.
• The final decision rests with the parent company, whether centralized or decentralized.
• Decentralized firms may delegate decision-making at subsidiary/regional HQ levels to the parent company.

Multinational Capital Budgeting & MNC's Value

• Value of a multinational company considers expected cash flows from parent and expected exchange rates.
• Value is the sum of the present values of all projected cash flows considered in the relevant currency and considering the exchange rate.
• The discount rate used is the weighted average cost of capital for the MNC.

Adjusting Project Assessment for Risk

• If an MNC is uncertain about project cash flows, a risk-adjusted discount rate might be used.
• The higher the uncertainty, the higher the discount rate applied.
• Using sensitivity or simulation methods to adjust for risk factors is also common.

Input for Multinational Capital Budgeting

• Initial Investment
• Consumer Demand
• Product Price
• Variable Cost
• Fixed Cost
• Project Lifetime
• Salvage Value
• Fund Transfer Restrictions

Capital budgeting analysis (Parent) - Example periods

• Detailed calculations for periods to determine demand, price per unit, total revenue, variable cost, annual lease expense, fixed expenses, noncash expenses, and before-tax earnings among other things.

Capital budgeting analysis - Example period

• Detailed calculations for periods to determine total cost, net cash flow, tax on remitted funds, remittance after amounts withheld, salvage value and cash flow to parent among other things.