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CHAPTER 17

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.

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CHAPTER 17

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  1. CHAPTER 17 CAPITAL BUDGETING FOR THE MULTINATIONAL CORPORATION

  2. CHAPTER OVERVIEW: • I. BASIS OF CAPITAL BUDGETING • II. ISSUES IN FOREIGN INVESTMENT • ANALYSIS • III. POLITICAL RISK ANALYSIS • IV. GROWTH OPTIONS AND PROJECT EVALUATION

  3. 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.

  4. 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

  5. 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

  6. 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

  7. 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

  8. BASICS OF CAPITAL BUDGETING • 4. Intangible Benefits • a. Valuable learning experience • b. Broader knowledge base

  9. 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

  10. 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

  11. 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

  12. ISSUES IN FOREIGN INVESTMENT ANALYSIS • 4. 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? 1. 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 • 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.

  15. 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.

  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: • 1. an important component of many investment decisions • 2. ignoring options will understate the NPV of that investment

  18. 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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