Ch06-VersC.ppt

Multinational Capital Budgeting

_{Multinational Capital Budgeting}

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14

ChapterChapter

South-Western/Thomson Learning © 2003

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}

Subsidiary versus Parent

Perspective

• _{Should the capital budgeting for a}

multi-national project be conducted from the viewpoint of the subsidiary that will

administer the project, or the parent that will provide most of the financing?

• _{The results may vary with the perspective}

Subsidiary versus Parent

Perspective

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.

Online Application

• _{For country-specific information such as}

general business rules, regulations and tax rates, visit:

– _{the Price Waterhouse Coopers site at}

http://www.pwcglobal.com,

– _{http://www.us.kpmg.com/microsite/Global_Tax/}

CTR_Survey/index.html

– _{the Yahoo! International Finance Center at http://}

Remitting Subsidiary Earnings to the Parent

After-Tax Cash Flows Remitted by Subsidiary Cash Flows Generated by Subsidiary

After-Tax Cash Flows to Subsidiary

Cash Flows Remitted by Subsidiary

Withholding Tax Paid to Host Government Retained Earnings

by Subsidiary Corporate Taxes

Paid to Host Government

Conversion of Funds to Parent’s Currency

Parent

Subsidiary versus Parent

Perspective

• _{A parent’s perspective is appropriate when}

evaluating a project, since any project that can create a positive net present value for the

parent should enhance the firm’s value.

• _{However, one exception to this rule may}

Input 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

The following forecasts are usually required:

Input for Multinational

Capital Budgeting

9.Tax laws

10.Exchange rates

11.Required rate of return

Online Application

• _{What is the expected economic growth rate}

for a particular country?

¤ _{Consult the Country Commercial}

Guides prepared by embassy staff at http://www.usatrade.gov/website/ccg. nsf/ccghomepage?openform.

¤ _{Refer to the CIA’s World Factbook at}

Multinational

Capital Budgeting

• _{Capital budgeting is necessary for all}

long-term projects that deserve consideration.

• _{One common method of performing the}

Multinational

Capital Budgeting

n

+





+ salvage value (1 + k )n

k = the required rate of return on the project n = project lifetime in terms of periods

Capital Budgeting Analysis

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)

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)

Factors to Consider in Multinational

Capital Budgeting

_{Exchange rate fluctuations. Different scenarios}

should be considered together with their probability of occurrence.

_{Inflation. Although price/cost forecasting}

implicitly considers inflation, inflation can be quite volatile from year to year for some

Factors to Consider in Multinational

Capital Budgeting

_{Financing arrangement. Financing costs are}

usually captured by the discount rate.

However, many foreign projects are partially financed by foreign subsidiaries.

_{Blocked funds. Some countries may require}

Factors to Consider in

Multinational Capital Budgeting

_{Uncertain salvage value. The salvage value}

typically has a significant impact on the project’s NPV, and the MNC may want to compute the

break-even salvage value.

_{Impact of project on prevailing cash flows. The}

new investment may compete with the existing business for the same customers.

_{Host government incentives. These should also}

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

Impact of Multinational Capital Budgeting on an MNC’s Value



 















E (CF_j,t ) = expected cash flows in currency j to be received by the U.S. parent at the end of

period t

E (ER_j,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

Chapter Review

• _{Subsidiary versus Parent Perspective}

– _{Tax Differentials}

– _{Restricted Remittances}

– _{Excessive Remittances}

– _{Exchange Rate Movements}

Chapter Review

• _{Factors to Consider in Multinational Capital}

Budgeting

– _{Exchange Rate Fluctuations} – _Inflation

– _{Financing Arrangement} – _{Blocked Funds}

– _{Uncertain Salvage Value}

Chapter Review

• _{Adjusting Project Assessment for Risk}

– _{Risk-Adjusted Discount Rate}

– _{Sensitivity Analysis}

– _Simulation

• _{Impact of Multinational Capital Budgeting on}