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International Capital Budgeting
International Capital Budgeting
Coal Wheat
US 2 units/ton 1 unit/ton
Germany 1 unit/ton 4 units/ton
Since the US is more efficient in the production of wheat, it will produce wheat; Germany
is more efficient in the production of coal; hence it will produce coal. The US will export
wheat to the Germany and import coal.
Assumptions: 1) Factors of production cannot move freely across countries.
2) Factors of production are not specialized.
Comparative Advantage
Number of units of factors of production required per unit of final product
Coal Wheat
US 2 units/ton 1 unit/ton
UK 3 units/ton 4 units/ton
Even though the US is more efficient in the production of both wheat and coal, it has a
comparative advantage in the production of wheat; hence, it will produce wheat; the UK
has a comparative advantage in producing coal; hence it will produce coal. The US will
export wheat to the UK and import coal.
Gains from Trade
Prior to the introduction of trade, the exchange rate between wheat and
coal in the US and UK must be as follows:
US 1 ton wheat = 0.5 tons of coal
UK 1 ton wheat = 1.33 tons of coal
The project has 4-year project life with cash flows given on the next
slide.
The appropriate expected exchange rates are given on the next slide.
International Capital Budgeting Example
International Capital Budgeting Issues
International diversification and risk reduction
First, it indicates that, at current exchange rates, foreign demand for U.S.
exports is far less than the U.S. demand for foreign goods.