F2: International Capital Budgeting

Question 1

What are the two approaches for “best guesses” on the opportunity cost of capital?

Answer 1

1: Find an alternative investment with equal risk and take its expected return
2: The firm’s WACC

Question 2

What is the NPV-formula containing a perpetuity?

Answer 2

The following formula is used if there is no buyer in the end and investments are held for a long time

Question 3

How is cost of capital calculated (CAPM)?

Answer 3

For pure equity financing the cost of capital is calculated as below
Remember, r_m, is the risk free return

Question 4

What is Beta?

Answer 4

1: β is the relationship between the average market return and the return of the firm we’re looking at (company specific risk)
2: If β > 1 the stock/firm is riskier than the market
3: If β = 1 the stock/firm is as risky as the market
4: If β < 1 the stock/firm is less risky than the market

Question 5

What is the NPV-formula containing FX?

Answer 5

When you invest from country A into country B the following formula is used to compute NPV
Remember: when S = 1,1 EUR/USD it means that 1,1 EUR = 1 USD

Question 6

How is additional risk in un-developed countries accounted for?

Answer 6

1: A coefficient indicating, among others, national default spread in the target country is added to the market risk premium
2: The world-market-β (β_WM) is replaced by the ratio of expected project standard deviation over expected standard deviation in the market portfolio

Question 7

What is the NPV-formula containing the possibility of expropriation?

Answer 7

Expropriation means that expected cash flows might not materialize. The below formula is used

Question 8

How is risk, that is diversifiable within a country, managed?

Answer 8

This is the three special types of NPV formulas where we adjust the cash flows, but r isn’t changed. This only works for risk we can diversify within a country because everything we cannot diversify within the country should go into the discount rate (r).

Question 9

How is risk, that isn’t diversifiable within a country, managed?

Answer 9

This is the three different formulas for r depending on how well integrated the financial markets are.

Question 10

What is the WACC formula?

Answer 10

It is as below

Question 11

The adjusted NPV (APV)?

Answer 11

The adjusted NPV (APV) approach considers the value of financing effects