CHAPTER-14

Multinational Capital
Budgeting
 CAPITAL BUDGETING TECHNIQUE-NPV

We determine that for an initial cash outflow of $100,000 for a project.

The Square Fish Farm expected to generate net cash flows of $34,432,
$39,530, $39,359, and $32,219 over the next 4 years. ROR = 12%.
NPV=???
10768 TK.
INITIAL CASH OUTFLOW
CASH INFLOW
TERMINAL YEAR INCREMENTAL CASH INFLOW
 PRACTICE
The Faversham Fish Farm is considering the introduction of a new fish-flaking
facility. To launch the facility, it will need to spend $90,000 for special equipment. The
equipment has a useful life of four years and is in the three-year property class for tax
purposes. Shipping and installation expenditures equal $10,000, and the machinery has an
expected final salvage value, four years from now, of $16,500. The machinery is to be
housed in an abandoned warehouse next to the main processing plant. The old
warehouse has no alternative economic use. No additional “net” working capital is
needed. The marketing department envisions that use of the new facility will generate
additional net operating revenue cash flows, before consideration of depreciation and
taxes, a follows:
YEAR 1 2 3 4
Net cash flows $35,167 $36,250 $55,725 $32,258
Assuming that the marginal tax rate equals 40 percent, we now need to estimate the
project’s relevant incremental cash flows.
ANSWER
INPUTS FOR MULTINATIONAL CAPITAL BUDGETING

 1. Initial Investment
 2. Price and Demand
 3. Costs-Variable and Fixed
 4. Tax Laws
 5. Remitted Funds
 6. Exchange Rates
 7. Salvage Value
 8. Required rate of Return
EXAMPLE (PROBLEM-13)
Brower, Inc., just constructed a manufacturing plant in Ghana. The construction cost is 9
million Ghanaian cedi. Brower intends to leave the plant open for three years. During
the three years of operation, cedi cash flows are expected to be 3 million cedi, 3 million
cedi, and 2 million cedi, respectively. Operating cash flows will begin one year from
today and are remitted back to the parent at the end of each year. At the end of the
third year, Brower expects to sell the plant for 5 million cedi. Brower has a required rate
of return of 17 percent. It currently takes 8,700 cedi to buy 1 U.S. dollar, and the cedi is
expected to depreciate by 5 percent per year.
 a. Determine the NPV for this project. Should Brower build the plant?
 b. How would your answer change if the value of the cedi was expected to remain
unchanged from its current value of 8,700 cedi per U.S. dollar over the course of the
three years? Should Brower construct the plant then?
MULTINATIONAL CAPITAL BUDGETING EXAMPLE

Spartan, Inc., is considering the development of a subsidiary in Singapore that would

manufacture and sell tennis rackets locally. Spartan’s financial managers have asked
the manufacturing, marketing, and financial departments to provide them with relevant
input so they can apply a capital budgeting analysis to this project. In addition, some
Spartan executives have met with government officials in Singapore to discuss the
proposed subsidiary. The project would end in four years. All relevant information follows.
1. Initial investment. The project would require an initial investment of 20 million
Singapore dollars (S$), which includes funds to support working capital. Given the
existing spot rate of $.50 per Singapore dollar, the U.S. dollar amount of the parent’s
initial investment is S$20 million X $.50 = $10 million. (S$1=$.5)
2. Price and consumer demand. The estimated price and demand schedules during
each of the next four years are shown here:
Year 1 Year 2 Year 3 Year 4
Price per unit S$350 S$350 S$360 S$380
Demand 60,000 units 60,000 units 100,000 units 100,000 units
MULTINATIONAL CAPITAL BUDGETING EXAMPLE
3. Costs. The variable costs (for materials, labor, etc.) per unit have been estimated
and consolidated as shown here:
Year 1 Year 2 Year 3 Year 4
Variable cost per S$200 S$200 S$250 S$280
unit

The expense of leasing extra office space is S$1 million per year. Other annual
overhead expenses are expected to be S$1 million per year.
4. Tax laws. The Singapore government will allow Spartan’s subsidiary to depreciate
the cost of the plant and equipment at a maximum rate of S$2 million per year,
which is the rate the subsidiary will use.
The Singapore government will impose a 20 percent tax rate on income. In
addition, it will impose a 10 percent withholding tax on any funds remitted by the
subsidiary to the parent.
The U.S. government will allow a tax credit on taxes paid in Singapore; therefore,
earnings remitted to the U.S. parent will not be taxed by the U.S. government.
MULTINATIONAL CAPITAL BUDGETING EXAMPLE

5. Remitted funds. The Spartan subsidiary plans to send all net cash flows received back
to the parent firm at the end of each year. The Singapore government promises no
restrictions on the cash flows to be sent back to the parent firm but does impose a
10 percent withholding tax on any funds sent to the parent, as mentioned previously.
6. Exchange rates. The spot exchange rate of the Singapore dollar is $.50. Spartan uses
the spot rate as its forecast for all future periods.
7. Salvage value. The Singapore government will pay the parent S$12 million to
assume ownership of the subsidiary at the end of four years. Assume that there is
no capital gains tax on the sale of the subsidiary.
8. Required rate of return. Spartan, Inc., requires a 15 percent return on this project.
 Practice Math

 Advanced Question-27
 Page - 463