14

Chapter

Multinational Capital Budgeting

 Subsidiary versus Parent
Perspective
• capital budgeting for MNC project can be
done from the point of
¤ subsidiary that will administer the project
¤ or the parent that will provide most of the
financing
• results may vary with the perspective due
to
¤ the net after-tax cash inflows to the parent
can differ substantially from those to the
subsidiary.
 Remitting Subsidiary Earnings to the Parent

Cash Flows Generated by Subsidiary Corporate Taxes

Paid to Host
Government
After-Tax Cash Flows to Subsidiary
Retained Earnings
by Subsidiary
Cash Flows Remitted by Subsidiary
Withholding Tax
Paid to Host
After-Tax Cash Flows Remitted by Subsidiary Government

Conversion of Funds
to Parent’s Currency
Cash Flows to Parent

Parent
 Why difference ?

The difference in cash inflows is 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.
• Exchange rate movements
Which is better perspective ?

• parent’s perspective
¤ as positive net present value for the parent
should enhance the firm’s value.
• exception to this rule
¤ when the foreign subsidiary is not wholly
owned by the parent.(partly owned)
 Input required for
Multinational
Capital Budgeting
The following forecasts are usually required:
1. Initial investment
2. Consumer demand
3. Product price
4. Variable cost
5. Fixed cost
6. Project lifetime
7. Salvage (liquidation) value
 Input for Multinational
Capital Budgeting

8. Fund-transfer restrictions
9. Tax laws
10. Exchange rates
11. Required rate of return
 Methods used in MNC
Capital budgeting
• Net present value (NPV) of the project.
• NPV = – initial outlay
n
+ S cash flow in period t
t =1 (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, the project can be accepted.
 Capital Budgeting Analysis- A model
Period t
1. Demand (1)
2. Price per unit (2)
3. Total revenue (1)(2)=(3)
4. Variable cost per unit (4)
5. Total variable cost (1)(4)=(5)
6. Annual lease expense (6)
7. Other fixed periodic expenses (7)
8. Noncash expense (depreciation) (8)
9. Total expenses (5)+(6)+(7)+(8)=(9)
10. Before-tax earnings of subsidiary (3)–(9)=(10)
11. Host government tax tax rate(10)=(11)
12. After-tax earnings of subsidiary (10)–(11)=(12)
 Capital Budgeting Analysis
Period t
13. Net cash flow to subsidiary (12)+(8)=(13)
14. Remittance to parent (14)
15. Tax on remitted funds tax rate(14)=(15)
16. Remittance after withheld tax (14)–(15)=(16)
17. Salvage value (17)
18. Exchange rate (18)
19. Cash flow to parent (16)(18)+(17)(18)=(19)
20. Investment by parent (20)
21. Net cash flow to parent (19)–(20)=(21)
22. PV of net cash flow to parent (1+k) - t(21)=(22)
23. Cumulative NPV SPVs=(23)
 Factors to Consider in
Multinational Capital Budgeting
 Exchange rate fluctuations.
 Different scenarios and probabilities
 Inflation.
 Financing arrangement.
 Subsidiary may have financed itself
 Parent may have financed subsidiary
 Other subsidiaries may have financed this subsidiary
 Blocked funds.
 Uncertain salvage value..
 Impact of project on prevailing cash flows.
 Host government incentives.
 Adjusting Project Assessment
for Risk
• If an MNC is unsure of the cash flows of a
proposed project, it needs to adjust its
assessment for this risk.
• One method is to use a risk-adjusted
discount rate. The greater the uncertainty,
the larger the discount rate that is applied.
• Many computer software packages are
also available to perform sensitivity
analysis and simulation.
Impact of Multinational Capital Budgeting
on an MNC’s Value
Multinational Capital Budgeting
Decisions

m 
n 
E CFj , t  E ER j , t 
 j 1 
Value =   
t =1  1  k  t

 
E (CFj,t ) = expected cash flows in currency j to be received
by the U.S. parent at the end of period t
E (ERj,t ) = expected exchange rate at which currency j can
be converted to dollars at the end of period t
k = weighted average cost of capital of the parent
 Exercise
• Revenue 60000x350 =2,16,00,000
• Variable cost
• For a foreign subsidiary of a MNC
¤ 300x60000 =1,80,00,000
following information is available ¤ Less :Fixed =6,00,000
• Demand -60000 units ¤
1,20,00,000
• Sale price-$350
• Contribution 96,00,000
• Total cash cost-$300
• Fixed cost 6,00,000
• Fixed cash cost-$6,00,000
• Cash Profit 90,00,000
• Non cash expenses-$20,00,000 • Non Cash exp 20,00,000
• Host government tax-20% • Tax@20% 14,00,000
• $to be remitted to subsidiary-50% • PAT 56,00,000
• Withholding tax-10% • Profit to be remitted 28,00,000

• Exchange rate-Rs50
• Withholding tax 2,80,000
• Amount remitted 25,20,000
• Discounting factor-10%
• Investment 100,00,000
• Initial investment-$10 Millions
• Total disc factor 3.79
• Find NPV for 5 Years • PV of inflows 9550800
• NPV -449200
 Exercise 2
• A parent company wishes to compute the net present value (NPV) of a
capital budgeting project for its German subsidiary. The initial investment
by the parent is $5,000,000. The project will last three years. Estimated
remittances to the parent by the German subsidiary are expected to be
€2,000,000, €3,000,000, and €2,000,000, in years 1, 2, and 3, respectively.
The current spot rate of the euro is $1.03. Exchange rates for the euro are
expected to be $1.05, $1.07, and $1.01 in years 1, 2, and 3, respectively. An
appropriate discount rate for this project is 12%. What is the NPV of this
project? Should the project be undertaken?
• a. NPV = $2,000,000; undertake project
b. NPV = $871,788; undertake project
c. NPV = $721,788; undertake project
d. NPV = $871,788; do not undertake project
e. NPV = $721,788; do not undertake project
 Solutions

1.00 $ Rs

1 0.89 2000000 1.05 1839168.00

2 0.80 3000000 1.07 2511180.00
3 0.71 2000000 1.01 1521540.00
5871888.00
5000000.00
871888.00
 MCQ
•

• 1. Which of the following would have a positive affect

on the cash flows received by a parent company from a
foreign subsidiary?
• a. blocked funds
b. an increase in the relative inflation rate of the host
country
c. host government incentives
d. both b and c
e. all of the above
• D
 MCQ
• 2. Which of the following
would have a negative
affect on the cash flows of
a foreign subsidiary?
• a. blocked funds
b. a currency depreciation
of the host currency
c. host government
incentives
d. all of the above
e. none of the above
• E
• 3. When adjusting project
assessment for risk, which of
the following is used to
generate a probability
distribution of net present
value (NPV) based on a range
of possible values for one or
more input variables?
• a. risk-adjusted discount rate
b. sensitivity analysis
c. simulation
d. both b and c
e. none of the above
• C
 MCQ

• 4. A withholding • 5. The parent's

tax affects the perspective should
cash flows of the always be used to
parent and the decide whether a
subsidiary. capital budgeting
project should be
• a. True
undertaken.
b. False
• B • a. True
b. False
• B
 MCQ

• 6. Once the relevant • 7. The net present value

cash flows for a (NPV) from the parent's
perspective is based on a
project have been comparison of the present
estimated, they value of the cash flows
should be discounted received by the parent to
at the MNC's cost of the initial outlay by the
capital. parent.
• a. True
• a. True b. False
b. False
• A
• b
 MCQ
• 8. From the viewpoint of
the parent, the joint impact
of inflation and exchange
rate fluctuations on a
subsidiary's net cash
flows may produce a
partially offsetting effect.
a. True
b. False
• A
• 9. Multinational capital
budgeting problems
should not include debt
payments in the
measurement of cash
flows, because all
financing costs are
captured by the discount
rate.
• a. True
b. False
• B
 Assignment 3
• You are Indian Parent Co having subsidiary in US
• The following information is available as to your US subisidiary
• Net profit = in USD (your Roll No in reverse)
• Non cash expenses-10% of Revenue
• Host government tax-30%
• $to be remitted to parent-60%
• Withholding tax-US10%, India -16%
• Exchange rate-Rs62
• Discounting factor-10%
• Revenue= 5 times of Net Profit
• Initial investment- = Double of Revenue
• Find NPV for 5 Years from Parent’s perspective in its currency
• Last date = 15-12-2014