Topic capital budgeting

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 I 0 = initial cash outlay

x t = net cash flow at t

k = cost of capital

n = investment horizon







t

k

X I

NPV

1

0

) 1

(

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

estimating: Incremental basis

flows to account for

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

-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

economic and political risk of project?

and Political Risk Adjustments:

period

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

III 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