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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 MNC’s 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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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. 14 .3 .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.

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.4 ¤ ¤ ¤ . Exchange rate movements 14 .

Remitting Subsidiary Earnings to the Parent Cash Flows Generated by Subsidiary After-Tax Cash Flows to Subsidiary Retained Earnings by Subsidiary Cash Flows Remitted by Subsidiary After-Tax Cash Flows Remitted by Subsidiary Conversion of Funds to Parent’s Currency Cash Flows to Parent Parent 14 .5 Corporate Taxes Paid to Host Government Withholding Tax Paid to Host Government .

since any project that can create a positive net present value for the parent should enhance the firm’s value. • However. 14 . one exception to this rule occurs when the foreign subsidiary is not wholly owned by the parent.6 .Subsidiary versus Parent Perspective • A parent’s perspective is appropriate when evaluating a project.

4. 2. Initial investment Consumer demand over time Product price over time Variable cost over time Fixed cost over time Project lifetime Salvage (liquidation) value 14 .Input for Multinational Capital Budgeting The following forecasts are usually required: 1.7 . 6. 7. 3. 5.

10. 9. 11. Restrictions on fund transfers Tax payments and credits Exchange rates Required rate of return 14 .8 .Input for Multinational Capital Budgeting The following forecasts are usually required: 8.

14 . • 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.Multinational Capital Budgeting • Capital budgeting is necessary for all long-term projects that deserve consideration.9 .

Multinational Capital Budgeting • NPV = – initial outlay + Σ t =1 n 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 > 0.10 . the project can be accepted. 14 .

Multinational Capital Budgeting Example: • Spartan.11 . is considering the development of a subsidiary in Singapore that will manufacture and sell tennis rackets locally. Inc. 14 .

Inc.Capital Budgeting Analysis: Spartan.12 . 14 .

Inc.13 .Capital Budgeting Analysis: Spartan. 14 .

5.Capital Budgeting Analysis 1. 6.14 . 2. 4. 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 14 . 3. 7.

19. 15. 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 14 .Capital Budgeting Analysis 13. 18. 14.15 . 16. 17.

different scenarios can be considered together with their probability of occurrence.16 . 14 .Factors to Consider in Multinational Capital Budgeting  Exchange rate fluctuations Since it is difficult to accurately forecast exchange rates.

Analysis Using Different Exchange Rate Scenarios: Spartan. Inc. 14 .17 .

Sensitivity of the Project’s NPV to Different Exchange Rate Scenarios: Spartan.18 . Inc. 14 .

inflation can be quite volatile from year to year for some countries.Factors to Consider in Multinational Capital Budgeting  Inflation Although price/cost forecasting implicitly considers inflation.19 . 14 .

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.20 . 14 .Factors to Consider in Multinational Capital Budgeting  Financing arrangement Financing costs are usually captured by the discount rate.

14 .21 .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.

22 . Inc. Assume that all funds are blocked until the subsidiary is sold. 14 .Capital Budgeting with Blocked Funds: Spartan.

14 .Factors to Consider in Multinational Capital Budgeting  Uncertain salvage value Since the salvage value typically has a significant impact on the project’s NPV.23 .  Impact of project on prevailing cash flows The new investment may compete with the existing business for the same customers. the MNC may want to compute the breakeven salvage value.

Adjusting Project Assessment for Risk • When an MNC is unsure of the estimated cash flows of a proposed project. 14 .24 . The greater the uncertainty. • One method is to use a risk-adjusted discount rate. it needs to incorporate an adjustment for this risk. the larger the discount rate that should be applied to the cash flows.

• 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.25 . 14 .Adjusting Project Assessment for Risk • An MNC may also perform sensitivity analysis or simulation using computer software packages to adjust its evaluation.