Multinational Financial Management Alan Shapiro 7th Edition Power Points by J.Wiley & Sons Joseph F Greco, Ph.D California State University, Fullerton CHAPTER 17 CAPITAL BUDGETING FOR THE MULTINATIONAL 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: 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 NPV Formula: n Xt NPV = − I + ∑ t ( + k ) t =1 where I0 = initial cash outlay xt= net cash flow at t k = cost of capital n = investment horizon BASICS OF CAPITAL BUDGETING Most important property of NPV technique: -focus on cash flows with respect to shareholder wealth 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 Important principle when estimating: Incremental basis 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 Getting the base case correct Rule of thumb: Incremental cash flows Global Global = corporate flow cash flow without with project project BASICS OF CAPITAL BUDGETING 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 Relevant cash flows become quite important 10 ISSUES IN FOREIGN INVESTMENT ANALYSIS 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 11 ISSUES IN FOREIGN INVESTMENT ANALYSIS 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 12 ISSUES IN FOREIGN INVESTMENT ANALYSIS Tax Factors: determine the amount and timing of taxes paid on foreign-source income 13 ISSUES IN FOREIGN INVESTMENT ANALYSIS B Issue #2 How to adjust for increased economic and political risk of project? Three Methods of Economic and Political Risk Adjustments: a Shortening minimum payback period b Raising required rate of return c Adjusting cash flows 14 ISSUES IN FOREIGN INVESTMENT ANALYSIS 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 15 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 16 POLITICAL RISK ANALYSIS B EXPROPRIATION - the extreme form of political risk C BLOCKED FUNDS 17 IV GROWTH OPTIONS AND PROJECT EVALUATION IV GROWTH OPTIONS AND PROJECT EVALUATION A Options: an important component of many investment decisions ignoring options will understate the NPV of that investment 18 GROWTH OPTIONS AND PROJECT EVALUATION B Project Evaluation Growth options require an expanded NPV rule Investments in emerging markets can be viewed as growth options 19 ...CHAPTER 17 CAPITAL BUDGETING FOR THE MULTINATIONAL CHAPTER OVERVIEW: I BASIS OF CAPITAL BUDGETING II ISSUES IN FOREIGN INVESTMENT ANALYSIS