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Chapter 14a

This document discusses factors to consider when performing capital budgeting for multinational projects, including analyzing the perspectives of the subsidiary versus the parent, dealing with exchange rate fluctuations, inflation, financing arrangements, blocked funds, uncertain salvage values, and risk adjustment. It provides an example of analyzing a potential tennis racket manufacturing project in Singapore from the parent company's perspective.

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Khadiza Tul Kobra Borna
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© Attribution Non-Commercial (BY-NC)
Available Formats
Download as PPT, PDF, TXT or read online on Scribd
60 views

Chapter 14a

This document discusses factors to consider when performing capital budgeting for multinational projects, including analyzing the perspectives of the subsidiary versus the parent, dealing with exchange rate fluctuations, inflation, financing arrangements, blocked funds, uncertain salvage values, and risk adjustment. It provides an example of analyzing a potential tennis racket manufacturing project in Singapore from the parent company's perspective.

Uploaded by

Khadiza Tul Kobra Borna
Copyright
© Attribution Non-Commercial (BY-NC)
Available Formats
Download as PPT, PDF, TXT or read online on Scribd
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Chapter

14

Multinational Capital Budgeting

South-Western/Thomson Learning 2006

Slides by Yee-Tien (Ted) Fu

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.
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Subsidiary versus Parent Perspective


Should the capital budgeting for a multinational 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.
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Subsidiary versus Parent Perspective


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
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Remitting Subsidiary Earnings to the Parent


Cash Flows Generated by Subsidiary Corporate Taxes Paid to Host Government

After-Tax Cash Flows to Subsidiary

Retained Earnings by Subsidiary Cash Flows Remitted by Subsidiary


Withholding Tax Paid to Host Government

After-Tax Cash Flows Remitted by Subsidiary Conversion of Funds to Parents Currency Cash Flows to Parent Parent

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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.

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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
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Input for Multinational Capital Budgeting


The following forecasts are usually required:
8. Restrictions on fund transfers 9. Tax payments and credits

10. Exchange rates


11. Required rate of return

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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.

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Multinational Capital Budgeting


NPV = initial outlay
+

S
t =1

cash flow in period t


(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.


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Multinational Capital Budgeting


Example:

Spartan, Inc. is considering the


development of a subsidiary in Singapore that will manufacture and sell tennis rackets locally.

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Capital Budgeting Analysis: Spartan, Inc.

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Capital Budgeting Analysis: Spartan, Inc.

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Capital Budgeting Analysis


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


13. 14. 15. 16. 17. 18. 19. 20. 21. 22. Period t Net cash flow to subsidiary (12)+(8)=(13) Remittance to parent (14) Tax on remitted funds tax rate(14)=(15) Remittance after withheld tax (14)(15)=(16) Salvage value (17) Exchange rate (18) Cash flow to parent (16)(18)+(17)(18)=(19) PV of net cash flow to parent (1+k) - t(19)=(20) Initial investment by parent (21) Cumulative NPV SPVs(21)=(22)

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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.

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Analysis Using Different Exchange Rate Scenarios: Spartan, Inc.

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Sensitivity of the Projects NPV to Different Exchange Rate Scenarios: Spartan, Inc.

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Factors to Consider in Multinational Capital Budgeting


Inflation

Although price/cost forecasting implicitly considers inflation, inflation can be quite volatile from year to year for some countries.

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Factors to Consider in Multinational Capital Budgeting


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.
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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.

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Capital Budgeting with Blocked Funds: Spartan, Inc.


Assume that all funds are blocked until the subsidiary is sold.

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Factors to Consider in Multinational Capital Budgeting


Uncertain salvage value

Since the salvage value typically has a significant impact on the projects NPV, the MNC may want to compute the breakeven salvage value.
Impact of project on prevailing cash flows

The new investment may compete with the existing business for the same customers.
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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.

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Adjusting Project Assessment for Risk


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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