Determinants of the cost of International Projects & their Management

by Rajat Jhingan PGDM FT (08-10)

Capital Budgeting
Capital budgeting requires estimation of a projects incremental cash flows - which are determined by estimating worldwide cash flows with and without the project. There are two main methods of international capital budgeting, centralized and decentralized Centralized requires exchange rate forecasts Decentralized requires a local-currency cost of capital. The method a firm selects should depend on its comparative advantage in estimating each
By: Rajat Jhingan

International Project : Objectives

Shareholders wealth is created when return in the Present Value is more than Investment Cost Firm that could source funds internationally rather domestically will have lower cost of capital.
Greater Opportunities to raise funds Positive NPVs

APV Model given by Donald Lessard (1985)

By: Rajat Jhingan

Determinants of cost of International Projects

Cash flows Marginal corporate tax rate Operating cash flow Incremental revenues & operating cost Restricted funds Concessionary loans WACC Additional Transfer Pricing Strategies, Licensing Agreements, Royalty Agreements
By: Rajat Jhingan

ADJUSTED PRESENT VALUE

Given by: Donald Lessard (1985) Value Additivity approach to capital budgeting. Each cash flow is discounted at a rate of discount consistent with the risk inherent in the cash flow. Useful for: MNC for analyzing one of its domestic capital expenditure Foreign subsidiary of the MNC, a proposed capital expenditure from the subsidiarys viewpoint. A project may have a positive APV from the subsidiarys perspective and a negative APV from the parents perspective. The model recognizes that the cash flows will be dominated in a foreign currency and will have to be converted into the currency of the parent. By: Rajat Jhingan

Estimate Future Expected Exchange Rate

It is required to Estimate Future Expected Exchange Rate in order to implement the APV framework. PPP theory is helpful in Estimate Future Expected Exchange Rate. St = So (1+ d) t (1+ f) t St= future expected exchange rate T= no of years d= expected long run annual rate of inflation in the home country F= rate of foreign land So= current exchange rate
By: Rajat Jhingan

Political Risk
Centralized capital budgeting requires expected cash flows to be adjusted for political risk - not cost of capital. Foreign political risk is unlikely to be systematic to the risks of domestic shareholder portfolios. Sensitivity analysis is an alternative to calculation of exact political risk probabilities: solve for probability that sets NPV=0 and then ask whether its reasonable if so, NPV is quite possibly negative.
By: Rajat Jhingan

Thank You!!!!

By: Rajat Jhingan