Multinational Capital Budgeting

Question 1

What are some points to look out for when analysisng the capital budgeting of an MNC’s subsidiary versus its parent

Answer 1

Tax Differentials: different tax rates may make a project feasible from a subsidiary’s perspective, but
not from a parent’s perspective.
Restrictions on Remitted Earnings:
Governments may place restrictions on whether earnings must remain in country. Excessive Remittances: if the parent company charges fees to the subsidiary, then a project
may appear favorable from a parent perspective, but not from a subsidiary’s perspective.
Exchange Rate Movements: earnings converted to the currency of the parent company will be affected.

Question 2

When should analysis be carried out from parents perspective vs subsidary perspective

Answer 2

The parent’s perspective is appropriate when evaluating a project since the parent’s shareholders are the owners and any project should generate sufficient cash flows to the parent to enhance shareholder wealth.
One exception is when the foreign subsidiary is not wholly owned by the parent and the foreign project is partially financed with retained
earnings of the parent and of the subsidiary.

Question 3

Describe the Process of remitting
subsidiary earnings to parent

Answer 3

Cash flows generated
Corporate taxes are paid to host government
After tax cash flows to subsidiary are then retained earnings for subsidary.
Cash flows remitted by subsidary withholding the tax paid to the host government are the after tax cash flows remitted by subsidiary.
Funds are converted to parents currency and transferred to parent.

Question 4

Define initial investment and costs as inputs for multinational capital budgeting

Answer 4

Initial investment - Funds initially invested include whatever is necessary to start the project and
additional funds, such as working capital, to support the project over time
Costs - Variable-cost forecasts can be developed from comparative costs of the components. Fixed costs can
be estimated without an estimate of consumer Wdemand

Question 5

What is future demand influenced by

Answer 5

Future demand is usually influenced by economic conditions, which are
uncertain

Question 6

What are the inputs for multinational capital budgeting

Answer 6

Initial investment
Price and consumer demand
Costs
Tax laws
Remitted funds - MNC policy for these
Exchange rates
Salvage (liquidation) values
Required rate of return

Question 7

How can an MNC derive the Required rate of return

Answer 7

The MNC should first
estimate its cost of capital, and then it can derive its
required rate of return on a project based on the risk
of that project.

Question 8

What is the formula for the NPV

Answer 8

-Inital outlay + Sum over all periods of Cash flows/(i+k)^t plus the salvage value/(1+k)^n

Where n= lifetime of project and cash flows summed are cash flows over period t

Question 9

How to calculate revenue

Answer 9

Demand x price per unit

Question 10

How do you calculate the total expenses for an MNC in capital budgeting

Answer 10

Variable cost per unit * demand = variable costs.
Add variable costs+fixed costs = total expenses

Note depreciation can be a noncash expense and included in this section it may just need to be added back in

Question 11

Before tax earnings of the subsidary in capital budegting analysis

Answer 11

Total revenue - total expenses

Question 12

Net cash flow to the subsidary

Answer 12

After tax earnings of subsidary +non cash expense for depreciation

Question 13

Formula for Cash remitted after withholding taxes

Answer 13

Cash remitted (equals 100% of net cash flows) minus tax withheld of remitted funds

Question 14

PV of Cash flows to parent calcualtion

Answer 14

Cash remitted to the parent after withholding taxes plus salvage value * exchange rate all discounted back by the required rate of return discount rate.

Question 15

Why might MNC reject the project even if NPV is positive

Answer 15

If the discount rate used has accounted for the projects risk fully then because NPV is positive MNC would accept this project. If the analysis has not yet accounted for risk, however, Spartan may decide to reject the project

Question 16

What are other factors to consider apart form the NPV of a project

Answer 16

Exchange rate fluctuations
Inflation
Financing arrangement
Blocked funds
Uncertain salvage value
Impact of project on prevailing cash flows
Host government incentives
Real options

Question 17

How can exchange rate fluctuations influence the NPV calculations for multinational capital budgeting?

Answer 17

Though exchange rates are difficult to forecast, a multinational capital budgeting analysis could incorporate other scenarios for exchange rate
movements, such as a pessimistic/optimistic scenario.
Exchange Rates Tied to Parent Currency - Some MNCs consider projects in countries where the local currency is tied to the dollar.
▪ Hedged Exchange Rates - Some MNCs may hedge the expected cash flows of a new project, so they should evaluate the project based on hedged exchange rates

Question 18

How can inflation influence the NPV calculations for multinational capital budgeting?

Answer 18

Should affect both costs and revenues.
Exchange rates of highly inflated countries tend to weaken over time (based on PPP).
The joint impact of inflation and exchange rate fluctuations may be partially offsetting effect
from the viewpoint of the parent

Question 19

If the parent arranges a financing agreement what does this affect int the multinational capital budgeting calculations?

Answer 19

Initial investment will go up after borrowing funds in subsidiary calcs

Question 20

What affect does increased investment by the parents have on exchange rate exposure

Answer 20

This revised example shows that the increased investment by the parent increases its exchange rate
exposure for the following reasons.
Parent provides the entire investment, no foreign financing is required. So, the subsidiary makes no interest payments and therefore
remits larger cash flows to the parent

Question 21

What affect does increased investment by parent have on salvage value and consequently exchange rates

Answer 21

The salvage value to be remitted to the parent is larger. Given the larger payments to the parent, the
cash flows ultimately received by the parent are more
susceptible to exchange rate movements

Question 22

Explain the idea of blocked funds

Answer 22

In some cases, the host country may block funds that the subsidiary attempts to send to the parent. Some countries require that earnings generated by the subsidiary be reinvested locally for at least
3 years before they can be remitted

The NPV of the project with blocked funds is usually substantially less than the oruginal NPV

Question 23

How is MNC amount to be remitted calculated with blcoked funds

Answer 23

Amounts are accumulated by reinvesting funds to be remitted and then in the first year they cna they are remitted. Tax to be withheld is charged on the total amount form all previous years

Question 24

What is the breakeven salvage value

Answer 24

Estimating break-even salvage value at zero NPV
MNC will accept a project if and only if the salvage value is estimated to be at least the break even salvage point

Question 25

Give a formula for the breakeven salvage value

Answer 25

(Inital investment - cash flows added up per time period discounted at required rate fo return) * (1+k)^n

Question 26

What is the impact of prevailing cash flows on MNC capital budgetng

Answer 26

Impact can be favorable if sales volume of parent increases following establishment of project. Impact can be unfavorable if existing cash flows decline following establishment of project

Question 27

What might host government incentives include

Answer 27

Low-rate host government loans
Reduced tax rates for subsidiary
Government subsidies of initial investment
Multinational capital budgeting

Question 28

What is the value fo real options derived from

Answer 28

Value is influenced by:
Probability that real option will be exercised
NPV that will result from exercising the real option

Question 29

How should a project assessment by adjusted for risk?

Answer 29

Risk-adjusted discount rate - greater the uncertainty about a project’s forecasted cash flows,
the larger the discount rate.
Sensitivity analysis - can be more useful than point estimates because it reassesses the project based on various circumstances.
Simulation - can be used for
generation of a probability distribution for NPV based on a range of possible values for one or more input variables.

Question 30

Why is POV when calculating MNC capital budgeting important

Answer 30

Capital budgeting may generate different results and a different conclusion depending on whether it is conducted from the perspective of an MNC’s subsidiary or from the perspective of the MNC’s parent. When a parent is deciding whether to implement an international project, it should determine whether the project is feasible from its own perspective