Multinational Capital Budgeting

South-Western/Thomson Learning © 2003 C14 - 1

 Chapter Objectives

• To compare the capital budgeting

analysis of an MNC’s subsidiary with that
of its parent;
• To demonstrate how multinational capital
budgeting can be applied to determine
whether an international project should be
implemented; and
• To explain how the risk of international
projects can be assessed.
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 Subsidiary versus Parent
Perspective
• Should the capital budgeting for a multi-
national project be conducted from the
viewpoint of the subsidiary that will
administer the project, or the parent that
will provide most of the financing?
• The results may vary with the perspective
taken because the net after-tax cash
inflows to the parent can differ
substantially from those to the subsidiary.
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 Subsidiary versus Parent
Perspective

The different in each cash flow is due to:

1. Tax Differentials: Different tax rates may make a

project feasible from a subsidiary’s perspective, but
not from a parent perspective.

2. Restriction on Remitted Earnings: Governments

may place restrictions on whether earnings must
remain in country.
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 Subsidiary versus Parent
Perspective

3. Excessive Remittances: If a parent company

charges fees to the subsidiary, then a project may
appear favorable from parent perspective, but not
from subsidiary perspective.

4. Exchange Rate Movements: Earnings connected to

the currency of the parent company will be affected
by exchange rate movements.

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 Remitting Subsidiary Earnings to the Parent

Cash Flows Generated by Subsidiary Corporate Taxes

Paid to Host
Government
After-Tax Cash Flows to Subsidiary
Retained Earnings
by Subsidiary
Cash Flows Remitted by Subsidiary
Withholding Tax
Paid to Host
After-Tax Cash Flows Remitted by Subsidiary Government

Conversion of Funds
to Parent’s Currency
Cash Flows to Parent

Parent
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 Subsidiary versus Parent
Perspective
• A parent’s perspective is appropriate
when evaluating a project, since any
project that can create a positive net
present value for the parent should
enhance the firm’s value.
• However, one exception to this rule may
occur when the foreign subsidiary is not
wholly owned by the parent.

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 Input for Multinational
Capital Budgeting
 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

 Price and consumer demand – Future demand is

usually influenced by economic conditions, which are
uncertain

 Variable Cost - cost forecasts can be developed from

comparative costs of the components. Fixed costs can
be estimated without an estimate of consumer C14 - 8
 Fixed Cost -is sensitive to any change in a host
country's inflation rate from the time the
forecast is made until the time fc are.

 Project Lifetime- Some projects have indefinite

lifetimes that can be difficult to asses while
other projects have designated specific
lifetimes.

 Tax laws – International tax effects must be

determined on any proposed foreign projects

 Remitted funds – The MNC policy for remitting

funds to the parent influences estimated cash
flows C14 - 9
 Exchange rates - These movements are often
very difficult to forecast
 Restriction of funds transfer -Host government
will prevent a subsidiary from sending its
earning to the parent.
 Salvage (liquidation) values - Depends on
several factors, including the success of the
project and the attitude of the host government
toward the project
 Required rate of return - 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.
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 Multinational
Capital Budgeting
• Capital budgeting is necessary for all
long-term projects that deserve
consideration.
• One common method of performing the
analysis is to estimate the cash flows and
salvage value to be received by the parent,
and compute the net present value (NPV)
of the project.

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 Multinational
Capital Budgeting
• NPV = – initial outlay
n
+ S cash flow in period t
t =1 (1 + k )t

+
salvage value
(1 + k )n
k = the required rate of return on the project
n = project lifetime in terms of periods
• If NPV > 0, the project can be accepted.
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 Factors to Consider in
Multinational Capital Budgeting
 Exchange rate fluctuations. Different
scenarios should be considered together
with their probability of occurrence.
 Inflation. Although price/cost forecasting
implicitly considers inflation, inflation can
be quite volatile from year to year for
some countries.

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 Factors to Consider in
Multinational Capital Budgeting
 Financing arrangement. Financing costs
are usually captured by the discount rate.
 Blocked funds. Some countries may
require that the earnings be reinvested
locally for a certain period of time before
they can be remitted to the parent.

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 Factors to Consider in
Multinational Capital Budgeting
 Uncertain salvage value. The salvage
value typically has a significant impact on
the project’s NPV, and the MNC may want
to compute the break-even salvage value.
 Impact of project on prevailing cash flows.
The new investment may compete with the
existing business for the same customers.
 Host government incentives. These
should also be considered in the analysis.
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 Adjusting Project Assessment
for Risk
• If an MNC is unsure of the estimated cash
flows of a proposed project, it needs to
incorporate an adjustment for this risk.
Three methods are commonly used to
adjust the evaluation for risk.
• One method is to use a risk-adjusted
discount rate. The greater the uncertainty,
the larger the discount rate that is applied.

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• Risk-Adjusted Discount Rate
- It is a discount rate which an investors
earn for taking risk in investing in a investment
proposal. The discount rate will be higher if the
project is more risky and if project is less risky
than the discount rate will be less.

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• Sensitivity analysis helps a business estimate
what will happen to the project if the
assumptions and estimates turn out to be
unreliable.

- involves considering alternative estimates

for the input variables and involves changing
the assumptions or estimates in a calculation to
see the impact on the project's finances.

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• Simulation is a method, wherein the infinite
calculations are made to obtain the possible
outcomes and probabilities for any choice of
action.

- Simulation involves repeating the analysis

many times using input values randomly drawn
from their respective probability distribution.

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 END
THANK YOU!!
Prepared by :
Erlyn David
Ivy Macale
Mabel Delatorre
Jc Laudes
Jearvyn Bueque

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