International Finance - 3 DAYS DUE
vzan0903
ch171.pptMultinational Financial Management
Alan Shapiro
7th Edition
J.Wiley & Sons
Power Points by
Joseph F. Greco, Ph.D.
California State University, Fullerton
CHAPTER 17
CAPITAL BUDGETING FOR THE MULTINATIONAL CORPORATION
CHAPTER OVERVIEW:
I. BASIS OF CAPITAL BUDGETING
II. ISSUES IN FOREIGN INVESTMENT
ANALYSIS
III. POLITICAL RISK ANALYSIS
IV. GROWTH OPTIONS AND PROJECT EVALUATION
I.BASICS OF CAPITAL BUDGETING
I. BASICS OF CAPITAL BUDGETING
A. Basic Criterion: Net Present Value
B. Net Present Value Technique:
1. Definition
The present value of future cash flows, discounted at the project’s cost of capital less the initial net cash outlay.
BASICS OF CAPITAL BUDGETING
2. NPV Formula:
where I0 = initial cash outlay
xt= net cash flow at t
k = cost of capital
n = investment horizon
BASICS OF CAPITAL BUDGETING
3. Most important property of NPV
technique:
-focus on cash flows with
respect to shareholder wealth
4. NPV obeys value additive principle:
- the NPV of a set of projects
is the sum of the individual project NPV
BASICS OF CAPITAL BUDGETING
C. International Cash Flows
1. Important principle when estimating: Incremental basis
2. Distinguish total from incremental
flows to account for
a. cannibalization
b. sales creation
c. opportunity cost
d. transfer pricing
e. fees and royalties
BASICS OF CAPITAL BUDGETING
3. Getting the base case correct
Rule of thumb:
Incremental Global Global
cash flows = corporate - flow
cash flow without
with project project
BASICS OF CAPITAL BUDGETING
4. Intangible Benefits
a. Valuable learning experience
b. Broader knowledge base
II. ISSUES IN FOREIGN INVESTMENT ANALYSIS
II. TWO ISSUES IN FOREIGN INVESTMENT ANALYSIS
A. Issue #1 Parent v. Project Cash Flow
-the cash flows from the project may
differ from those remitted to the parent
1. Relevant cash flows become quite
important
ISSUES IN FOREIGN INVESTMENT ANALYSIS
2. Three Stage Approach
-to simplify project evaluation
a. compute subsidiary’s project
cash flows
b. evaluate the project to the parent
c. incorporate the indirect effects
ISSUES IN FOREIGN INVESTMENT ANALYSIS
3. Estimating Incremental Project Flows
What is the true profitability of the
project?
a. Adjust for tax effects of
1.) transfer pricing
2.) fees and royalties
ISSUES IN FOREIGN INVESTMENT ANALYSIS
4. Tax Factors:
determine the amount and timing
of taxes paid on foreign-source
income.
ISSUES IN FOREIGN INVESTMENT ANALYSIS
B. Issue #2 How to adjust for increased
economic and political risk of project? 1. Three Methods of Economic and Political Risk Adjustments:
a. Shortening minimum payback period
b. Raising required rate of return
c. Adjusting cash flows
ISSUES IN FOREIGN INVESTMENT ANALYSIS
2. Accounting for Exchange Rate and Price Changes (inflationary)
Two stage procedure:
a. Convert nominal foreign cash flows into home currency terms
b. Discount home currency flows
at domestic required rate of return.
III. POLITICAL RISK ANALYSIS
I. POLITICAL RISK ANALYSIS
A. Political risks
can be incorporated into an NPV analysis by
- adjusting expected project cash
flows to reflect the risks.
POLITICAL RISK ANALYSIS
B. EXPROPRIATION
- the extreme form of political risk
C. BLOCKED FUNDS
IV. GROWTH OPTIONS AND PROJECT EVALUATION
IV. GROWTH OPTIONS AND PROJECT EVALUATION
A. Options:
1. an important component of many investment decisions
2. ignoring options will understate the NPV of that investment
GROWTH OPTIONS AND PROJECT EVALUATION
B. Project Evaluation
1. Growth options require an expanded NPV rule
2. Investments in emerging markets can be viewed as growth options
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