Multinational Financial Management
Alan Shapiro
10th Edition
John Wiley & Sons, Inc.
PowerPoints by
Joseph F. Greco, Ph.D.
California State University, Fullerton
1
CHAPTER 17
Capital Budgeting for the
Multinational Corporation
BASICS OF CAPITAL
BUDGETING
I.
BASICS OF CAPITAL BUDGETING
A. Basic Criterion: Net Present Value
B. Net Present Value Technique:
1. Definition
The present value of future cash flows,
discounted at the project’s cost of
capital less the initial net cash outlay.
BASICS OF CAPITAL
BUDGETING
2.
NPV Formula:
n
NPV   I 0  
t 1
xt
t
(1  k )
where I0
xt
k
=
=
=
initial cash outlay
net cash flow at t
cost of capital
n
=
investment horizon
BASICS OF CAPITAL
BUDGETING
3. Most important property of
NPV technique:
-focus on cash flows with respect to
shareholder wealth
4. NPV obeys value additive
principle:
- the NPV of a set of projects is the
sum of the individual project NPV
BASICS OF CAPITAL
BUDGETING
C. International Cash Flows
1. Important principle when estimating:
Use incremental basis
BASICS OF CAPITAL
BUDGETING
2. Distinguish total from incremental flows
to account for
a.
b.
c.
d.
e.
cannibalization
sales creation
opportunity cost
transfer pricing
fees and royalties
BASICS OF CAPITAL
BUDGETING
3.
Getting the base case
correct-Rule of thumb:
 GlobalCorporate   GlobalCorporate 
Incremental

 
 

CashFlow

 =  CashFlow
 

 CashFlows   withProject
  WithoutProject 

 

4. Intangible Benefits:
a. Valuable learning experience
b. Broader knowledge base
ALL-EQUITY COST OF CAPITAL
II.
Alternative Capital-Budgeting
Frameworks
A. THE ALL-EQUITY COST OF CAPITAL FOR
FOREIGN PROJECTS
WACC sometimes awkward
1. To go from the parent to the project
2. Solution: Use all-equity discount rate
3. To calculate:
k* = rf + *( rm - rf )
ALL-EQUITY COST OF CAPITAL
4. β* is the all-equity beta associated with
the unlevered cash flows.
5. Unlevered beta obtained by
 
*
where
e
1  1  t  D / E
β*
D/E
t
= the firm’s stock price beta
= the debt to equity ratio
= the firm’s marginal tax rate
FOREIGN INVESTMENT
ANALYSIS
III.
TWO ISSUES IN FOREIGN INVESTMENT
ANALYSIS
A. Issue #1
Parent v. Project Cash Flow
-the cash flows from the project may
differ from those remitted to the parent
1. Relevant cash flows become quite
important
FOREIGN INVESTMENT
ANALYSIS
2. Three Stage Approach
-to simplify project evaluation
a. compute subsidiary’s project cash flows
b. evaluate the project to the parent
c. incorporate the indirect effects
FOREIGN INVESTMENT
ANALYSIS
3. Estimating Incremental Project Flows
What is the true profitability of the project?
a. Adjust for tax effects of
1.)
transfer pricing
2.)
fees and royalties
FOREIGN INVESTMENT
ANALYSIS
4. Tax Factors:
determine the amount and timing of taxes paid
on foreign-source income
FOREIGN INVESTMENT
ANALYSIS
B. Issue #2
How to adjust for increased economic and political risk
of project?
FOREIGN INVESTMENT
ANALYSIS
1. Three Methods for Economic/Political
Risk Adjustments:
a. Shortening minimum payback period
b. Raising required rate of return
c. Adjusting cash flows
FOREIGN INVESTMENT
ANALYSIS
2. Accounting for Exchange Rate and Price
Changes (inflationary)
Two stage procedure:
a. Convert nominal foreign cash flows
into home currency terms
b. Discount home currency flows at
domestic required rate of return.
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