14

Multinational Capital Budgeting

Chapter Objectives
This chapter will:
Demonstrate how multinational capital budgeting can be applied to
determine whether an international project should be implemented

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 Capital Budgeting

 Capital budgeting is the planning process used to

determine whether an organization's long
term investments such as new machinery, new plants
and research development projects are worth pursuing.
 Based on cost benefit analysis.
 Based on PV of cash inflow – PV of cash outflow
(uses discount rate)
 Important – International projects are irreversible;
can not be sold out easily.

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 Input for Multinational Capital
Budgeting
1. Initial investment
2. Price and consumer demand
3. Costs
4. Taxes
5. Remitted funds
6. Exchange rates
7. Salvage value
8. Required rate of return – returns the MNC wants on the
project,

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 Spartan Inc.

1. Our company is considering a subsidiary in Singapore

to manufacture and sell tennis rackets there. The
project would end in four years.
2. We will get a salvage value at the end of the
project.

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 Capital Budgeting Analysis: Spartan, Inc.

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 Calculation of NPV

n
CFt SVn
NPV   IO   
t 1 (1  k ) t
(1  k ) n

Where:
IO = initial outlay (investment)
CFt = cash flow in period t
SVn = salvage value
k = required rate of return on the project
n = lifetime of the project (number of periods)
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 Hedging Exchange Rates

1. MNC can choose to hedge all of or a portion of their

cash flows

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 Details Year 1 Year 2 Year 3 Year 4

Total cash $5,400,000 $5,400,000 $6,840,000 $7,560,000

Hedged cash $4,000,000 $4,000,000 $4,000,000 $4,000,000
flows
$1,400,000 $1,400,000
Unhedged cash $2,840,000 $3,560,000
flows
Salvage value $12,000,000

Forward rate $.48 $.48 $.48 $.48

Spot rate $.50 $.50 $.50 $.50

Hedged cash $1,920,000 $1,920,000 $1,920,000 $1,920,000

Unhedged cash $700,000 $700,000 $1,420,000 $7,780,000

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 Foreign Exchange Fluctuation

1. From the parent company’s point of view

appreciation of the host country’s currency would be
to their advantage because the earnings received by
the subsidiary when be converted and sent home, the
company would benefit from the appreciation

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 Exhibit 14.3 Analysis Using Different Exchange Rate
Scenarios: Spartan, Inc.

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 Blocked Funds - May include requirements that earnings be
reinvested locally rather than repatriated.

1. In some cases the host country will prevent the

subsidiary from remitting funds to the parent
company.
2. Some countries will require the funds to remain in the
country for 3 years before the subsidiary can remit
funds to the parent company

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 Exhibit Capital Budgeting with Blocked Funds: Spartan, Inc.
(Invested at 5% per annum)

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Other Factors to Consider

Uncertain Salvage Value

The salvage value of an MNC’s project typically has a
significant impact on the project’s NPV.
1.Consider estimating break-even salvage value at zero NPV.
Breakeven Salvage Value:

 CFt 
SVn   IO   t 
(1  k ) n

 (1  k ) 

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 Other Factors: Host Government
Incentives
1. Low-rate host government loans
2. Reduced tax rates for subsidiary
3. Government subsidies of initial investment
4. Real option
5. Inflation

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 Other Factors:
Exchange Rate
Fluctuations

Sensitivity of the
Project’s NPV to
Different
Exchange
Rate Scenarios:
Spartan, Inc.
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 Questions
Qus 2

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 Other Factors: Impact of Project on
Prevailing Cash Flows
Impact can be favorable if sales volume of parent
increases following establishment of project.

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 Questions
Qus 3

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 If a U.S. parent is setting up a French subsidiary, and funds from the
subsidiary will be periodically sent to the parent, the ideal situation
from the parent's perspective is a ____ after the subsidiary is
established.

a. strengthening euro
b. stable euro
c. weak euro
d. B and C are both ideal.

Ans : A

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 When evaluating international project cash flows, which of the
following factors is relevant?

a. future inflation.
b. blocked funds.
c. exchange rates.
d. all of the above

Ans : D

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 Blocked funds may penalize a project if the return on the forced
reinvestment in the foreign country is less than the required rate of
return on the project.

a. True
b. False

Ans : True

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 Assume an MNC establishes a subsidiary where it has no other
existing business. The present value of parent cash flows from this
subsidiary is more sensitive to exchange rate movements when:

a. the subsidiary finances the entire investment by local

borrowing.
b. the subsidiary finances most of the investment by local
borrowing.
c. the parent finances most of the investment.
d. the parent finances the entire investment.

Ans : D

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 If the parent charges the subsidiary high administrative fees, the
earnings from the project will appear low to the parent and high to the
subsidiary.

a. True
b. False

Ans : False

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 Question

1. Blocked funds may penalize a project if the return on

the forced reinvestment in the foreign country is less
than the required rate of return on the project
True
False

True

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 Question

Other things being equal, a blocked funds restriction is more likely to have a
significant adverse effect on a project if the currency of that country is
expected to ____ over time, and if the interest rate in that country is
relatively ____.
a)appreciate; low
b)appreciate; high
c)depreciate; high
d)depreciate; low
D

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 Question

Exchange rates for purposes of multinational capital

budgeting:
a)are very difficult to forecast
b)can be easily hedged with currency swaps
c)are unimportant, as they do not affect the cash flows of
the multinational project
d)all of the above
A

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 Question

The required rate of return used to discount the relevant

cash flows from a foreign project may differ from the
MNC's cost of capital because of that particular project's
risk.
a)True
b)False

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 Question

Other things being equal, firms from a particular home

country will engage in more international acquisitions if
they expect foreign currencies to ____ against their home
currency, and if their cost of capital is relatively ____.
a)appreciate; low
b)appreciate; high
c)depreciate; high
d)depreciate; low
A

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