International Capital

Budgeting
Investment Decision
 Calculation of the cash flows associated with the project
 Cost of funding the project
 Cash inflows during the life of the project
 Terminal or ending value of the project

What matters is not the project’s total cash flow per period,
but the incremental cash flows generated by the project.
Incremental Cash Flow
 Cannibalization (a new product taking sales away from the
firm’s existing products)
 Sales Creation
 Opportunity Cost
 Transfer Pricing
 Fees and Royalties
 Accounting for Intangible Benefits
Adjusted Present Value (APV)
Project Cash Flows
 Adjust the effects of transfer pricing, fees and royalties
 Market costs/prices for goods, services, and capital transferred internally
 Impact of fees and royalties to project cash flows (Holding/Subsidiary)
 Remove the fixed portions of costs such as corporate overhead

 Adjustment of global costs/benefits that are not reflected in the project’s

financial statements
 Cannibalization of sales of other units
 Creation of incremental sales by other units
 Additional taxes owed when repatriating profits
 Foreign tax credits usable elsewhere
 Diversification of production facilities
 Market diversification
 Knowledge of competitors, technology, markets, and products
Establishment under FEMA
 Liaison Office
 Represent foreign company in the local country
 Promote export from or import to Local
 Encourage technical/financial collaboration between parent or group
companies and domestic companies
 Act as a communication channel
 Branch Office (Only trading activities are allowed)
 Subsidiary
 Independent Company
Tax Consideration
 Branch Vs Subsidiary
 Income Tax Rate
 Withholding Tax Rate
 Repatriation Tax Rate
 Effective Tax Rate for Project
 Concept of Tax Havens
Political and Economic Risk
 Shortening the minimum payback period
 Raising the required rate of return of the investment
 Adjusting cash flows to reflect the specific impact of a given
risk
PDCIL Ltd. is a leading manufacturer of a packaging containers.
The company has two divisions - Engineering and Assembly. The
output of the engineering division is transferred to the assembly
division for further processing and assembling before being sold
to the customer as complete product. Verification of the
company’s records reveals that the variable cost per unit of the
product for engineering and assembly are Rs. 250 and Rs. 300
respectively. The fixed cost of engineering division is Rs. 15,000
and that of the assembly division is Rs. 10,000. The product
variable cost per unit of engineering division is Rs. 400, and the
total output is 100 units which are sold to customer on
completion @ Rs. 2000 per unit. If the engineering division
decides to charge its transfers to assembly division at cost plus
150%, what will be PDCIL’s overall profit and the profits of its two
divisions?
Particulars Divisions Total

Engineering Assembly

Revenue (150% of the cost) 1,20,000 2,00,000 2,00,000

Product Variable Cost 40,000 - 40,000

Transferred Cost - 1,20,000

Division Variable Cost 25,000 30,000 55,000

Division Fixed Cost 15,000 10,000 25,000

Total Cost 80,000 1,60,000 1,20,000

Profit 40,000 40,000 80,000

Additional Methods in Transfer Pricing
 if the engineering division decides to price its transfers to
assembly division at the prevailing (current) market rate of
Rs 1000 per unit for similar products, what is the company’s
overall profit and so also of its two divisions?
 if the two divisions bargain to fix Rs. 1,150 per unit at which
engineering division should price its transfers to assembly
division, what will be the profits of the two divisions vis-a-vis
that of the company?
EMC Limited is the manufacturer of a certain electronic
product. The company has three divisions—D1 D2 and D3.
Output of D1 is transferred to D2 and that of D2 to D3 for
further processing and assembling before they are passed on to
the hands of the customer as final product. The company
reports that variable costs per unit of the product for D1, D2
and D3 are Rs. 300, Rs. 200 and Rs. 100, respectively. The fixed
costs for the three divisions are Rs. 20,000, Rs. 15,000 and Rs.
10,000 respectively. The product variable cost per unit is Rs.
400 for division D1. If the total output of the company for a
certain period is 1,000 units, which are sold to the customer at
Rs. 1,400 per unit, and if division D1 decides to charge its
transfers to D2 at cost plus 120% and D2 to D3 at cost plus
110%, what is the company’s total profit and the profits of its
divisions?