Chapter 18
Multinational Capital Budgeting
1
Multinational Capital Budgeting
• Extension of the domestic capital budgeting
analysis to evaluate a Greenfield foreign project
• Distinctions between the project viewpoint & the
parent viewpoint when analyzing a potential
foreign investment
• Adjusting the capital budgeting analysis of a
foreign project for risk
• Introduction of the use of real option analysis as
a complement to DCF analysis in the evaluation
of potential international investments
2
Multinational Capital Budgeting
• Like domestic capital budgeting, this focuses on
the cash inflows and outflows associated with
prospective long-term investment projects
• Capital budgeting follows same framework as
domestic budgeting
– Identify initial capital invested or put at risk
– Estimate cash inflows, including the terminal value or
salvage value of the investment
– Identify appropriate discount rate for NPV calculation
– Determine the NPV and IRR
3
Complexities of Budgeting for a
Foreign Project
• Several factors make budgeting for a foreign project
more complex
– Parent cash flows must be distinguished from project
– Parent cash flows often depend on the form of financing,
thus cannot clearly separate cash flows from financing –
this changes the meaning of NPV
– Additional cash flows from new investment may in part or
in whole take away from another subsidiary; thus as a
stand alone a project may provide cash flows but overall
may add no value to the entire organization
– Parent must recognize remittances from foreign
investment because of differing tax systems, legal and
political constraints
4
Complexities of Budgeting for a
Foreign Project
• Non-financial payments can generate cash flows to parent
in the form of licensing fees, royalty payments, etc. –
relevant for parent’s perspective
• Managers must anticipate differing rates of national
inflation which can affect cash flows
• Use of segmented national capital markets may create
opportunity for financial gains or additional costs
• Use of host government subsidies complicates capital
structure and parent’s ability to determine appropriate
WACC
• Managers must evaluate political risk
• Terminal value is more difficult to estimate because
potential purchasers have widely divergent views
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Project versus Parent Valuation
• Most firms evaluate foreign projects from both parent
and project viewpoints
– The parent’s viewpoint analyzes investment’s cash flows as
operating cash flows instead of financing due to
remittance of royalty or licensing fees and interest
payments
– Funds that are permanently blocked from repatriation are
excluded
• The parent’s viewpoint gives results closer to
traditional NPV capital budgeting analysis
• Project valuation provides closer approximation of
effect on consolidated EPS
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Project versus Parent Valuation
START
Parent Firm (US)
US$ invested in overseas
Foreign Investment
Particular investment
END
Is the project investment
Justified (NPV > 0)?
Parent Viewpoint
Capital Budget
(U.S. dollars)
Estimated cash flows
of project
Cash flows remitted
to Parent (FC to US$)
Project Viewpoint
Capital Budget
(Local Currency)
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Project Assumptions
• Financial assumptions
– Capital Investment – cost to build a plant
– Financing – depending on financing methods
WACC should be calculated for both the project
and parent
– Revenues
– Costs
– Exchange rate assumption – parent’s cash flows
are converted into home currency
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Estimating Cash Flows from Project
Viewpoint
• Project Viewpoint Capital Budget
– Estimate the free cash flows of the project by
determining EBITDA and not EBT
– Taxes are calculated based on this amount
Net operating cash flow (NOCF)  Operating profits - Taxes
Net operating cash flow (NOCF)  EBITDA  Taxes
Net operating cash flow (NOCF)  EBT  Depreciati on  Amortizati on  Interest  Taxes
– Net Operating Cash Flow = Net Operating Profit
After Tax
– NOCF = NOPAT
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Estimating Cash Flows from Project
Viewpoint (Continued)
• Project Viewpoint Capital Budget
– Estimate and incorporate net working capital and
capital spending
– Free Cash Flow (FCF) = Net Operating Cash Flow –
Changes in Net Working Capital – Changes in Fixed
Assets
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Estimating Cash Flows from Project
Viewpoint (Continued)
• Project Viewpoint Capital Budget
– Terminal value is calculated for the continuing value of
the project after the investment horizon
• TV is calculated as a perpetual net operating cash flow after
the investment horizon
Terminal Value 
NOCFLast year of holding( 1  g)
kW ACC  g
where g is the growth rate of NOCF.
• All FCFs and Terminal Value is discounted using
subsidiary WACC.
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Parent Viewpoint
• Parent Viewpoint Capital Budget
– Cash flows estimates are constructed from parent’s
viewpoint
• Estimate individual cash flows to parent after adjusting for
withholding taxes. These cash flows must be in parent firm’s
currency
• Use parent firm’s investment in subsidiary to determine NPV
at parent’s WACC
– Parent must now use it’s cost of capital and not the
project’s
– Parent may require an additional yield for
international projects
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Sensitivity Analysis
• Project Valuation Sensitivity Analysis
– Political risk – biggest risk is blocked funds or
expropriation
• Analysis should build in these scenarios and answer
questions such as how, when, how much, etc.
– Foreign exchange risk
• Analysis should also consider appreciation or
depreciation of the US dollar
13
Real Options
• Real Option Analysis
– DCF analysis cannot capture the value of the
strategic options, yet real option analysis allows
this valuation
– Real option analysis includes the valuation of the
project with future choices such as
•
•
•
•
The option to defer
The option to abandon
The option to alter capacity
The option to start up or shut down (switching)
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Real Options (Continued)
• Real Option Analysis
– Real option analysis treats cash flows in terms of
future value in a positive sense whereas DCF
treats future cash flows negatively (on a
discounted basis)
– The valuation of real options and the variables’
volatilities is similar to equity option math
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