ISSUES IN FOREIGN
INVESTMENT ANALYSIS
CAPITAL BUDGETING
6/30/2014Anu Damodaran2
6/30/2014Anu Damodaran3
Capital budgeting to a company
is what buying stocks or bonds is
to individuals
6/30/2014Anu Damodaran4
• Estimate cash flows (inflows &
outflows).
• Assess risk of cash flows.
• Determine appropriate discount
rate (r = WACC) ...
EVALUATION METHODS
 Payback (Payback Period = Cost of Project / Annual Cash Inflows)
 Discounted Payback (DCF = Actual C...
Project’s Cash Flows
(CFt)
Market
interest rates
Project’s
business risk
Market
risk aversion
Project’s
debt/equity capaci...
CAPITAL BUDGETING FOR
FOREIGN PROJECTS
 MORE COMPLICATIONS
 Multiple currencies
 Multiple tax rates
 Multiple tax syst...
Issues in Foreign Investment
Analysis
1. Parent Vs. Project Cash Flows
2. Tax Issue
3. Exchange Control
4. Subsidized Fina...
1. Project cash flows computed from subsidiaries
side (separate entity)
2. Specific forecasts concerning the amounts,
timi...
6/30/2014Anu Damodaran11
6/30/2014Anu Damodaran12
Host country and home
country tax
Earnings - host country tax
net + withholding tax
(distribution)
Earnings - further taxe...
Repatriation of earnings to
parent
Government
and
international
agencies
Add value of loan to
project at the time of
inves...
There are knock-on effects from
one country to another. For
example, investment in a
subsidiary in country X affects
cash ...
For proper evaluation of expected cash flows
from overseas project first the impact of
offsetting inflation and exchange r...
6/30/2014Anu Damodaran17
Loss of exports
Take care of in case of
marginal project or a project
that is not acceptable on the
basis of merits, benefits
should be qu...
RISK ANALYSIS
Political risk
Financial risk (Exchange rate
Risk, Inflation/Purchasing power
risk, Interest rate risk)
Othe...
Expropriation element contributes to divergence in cash flows of the
project and cash flows available to the parent compan...
METHODS IN INCORPORATION
OF RISKS
Associate local government with the
project, insurance
Shortening the payback period
Rai...
EVALUATION OF OVERSEAS
PROJECTS – INFORMATION
REQUIRED
 Net Investment Outlay
 Estimating Streams of Cash Benefits
 Est...
6/30/2014Anu Damodaran23
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  • For value box in Ch 4 time value FM13.
  • Issues in foreign investment

    1. 1. ISSUES IN FOREIGN INVESTMENT ANALYSIS
    2. 2. CAPITAL BUDGETING 6/30/2014Anu Damodaran2
    3. 3. 6/30/2014Anu Damodaran3
    4. 4. Capital budgeting to a company is what buying stocks or bonds is to individuals 6/30/2014Anu Damodaran4
    5. 5. • Estimate cash flows (inflows & outflows). • Assess risk of cash flows. • Determine appropriate discount rate (r = WACC) for project. • Evaluate cash flows. (Find NPV or IRR etc.) • Accept/Reject Decision 6/30/2014Anu Damodaran5
    6. 6. EVALUATION METHODS  Payback (Payback Period = Cost of Project / Annual Cash Inflows)  Discounted Payback (DCF = Actual Cash flows / [1 + i]^n)  Internal Rate of Return (IRR) 0 = P0 + P1/(1+IRR) + P2/(1+IRR)2 + P3/(1+IRR)3 + . . . +Pn/(1+IRR)n  Modified Internal Rate of Return (MIRR) = number of periods (√ Sum of Terminal Cash Flows other than Initial Investment / Initial Investment ) − 1  Profitability Index (PI) = Present Value of Future Cash Flows /Initial Investment Required  Net Present Value (NPV) 6/30/2014Anu Damodaran6
    7. 7. Project’s Cash Flows (CFt) Market interest rates Project’s business risk Market risk aversion Project’s debt/equity capacity Project’s risk-adjusted cost of capital (r) The Big Picture: The Net Present Value of a Project NPV = + + ··· + − Initial cost CF1 CF2 CFN (1 + r )1 (1 + r)N(1 + r)2 6/30/2014Anu Damodaran7
    8. 8. CAPITAL BUDGETING FOR FOREIGN PROJECTS  MORE COMPLICATIONS  Multiple currencies  Multiple tax rates  Multiple tax systems  Exchange rate fluctuations  Capital flow restrictions  Project specific subsidization – host government  Project specific penalties – host government  Valuing and investing – local currency of host vs domestic currency of parent 6/30/2014Anu Damodaran8
    9. 9. Issues in Foreign Investment Analysis 1. Parent Vs. Project Cash Flows 2. Tax Issue 3. Exchange Control 4. Subsidized Finance 5. Knock-on Effects 6. Exchange Rate Changes and Inflation 7. Loss due to lost Exports 8. International Diversification Benefits 9. Political Risk 6/30/2014Anu Damodaran9
    10. 10. 1. Project cash flows computed from subsidiaries side (separate entity) 2. Specific forecasts concerning the amounts, timing of distributable cash expenses that will be incurred in the process of transfer from parent side 3. Indirect benefits and costs , such as an increase or decrease in export sales by another partner Parent VS Project 6/30/2014Anu Damodaran10
    11. 11. 6/30/2014Anu Damodaran11
    12. 12. 6/30/2014Anu Damodaran12
    13. 13. Host country and home country tax Earnings - host country tax net + withholding tax (distribution) Earnings - further taxed in home country 6/30/2014Anu Damodaran13 After tax cash flows
    14. 14. Repatriation of earnings to parent Government and international agencies Add value of loan to project at the time of investment decision Financing below market rates 6/30/2014Anu Damodaran14
    15. 15. There are knock-on effects from one country to another. For example, investment in a subsidiary in country X affects cash flows of a subsidiary in country Y 6/30/2014Anu Damodaran15
    16. 16. For proper evaluation of expected cash flows from overseas project first the impact of offsetting inflation and exchange rate exchanges needs to be removed 6/30/2014Anu Damodaran16
    17. 17. 6/30/2014Anu Damodaran17 Loss of exports
    18. 18. Take care of in case of marginal project or a project that is not acceptable on the basis of merits, benefits should be quantified and taken care of 6/30/2014Anu Damodaran18
    19. 19. RISK ANALYSIS Political risk Financial risk (Exchange rate Risk, Inflation/Purchasing power risk, Interest rate risk) Other risks (Cost overruns and bad management) 6/30/2014Anu Damodaran19
    20. 20. Expropriation element contributes to divergence in cash flows of the project and cash flows available to the parent company In case of funds to be blocked in perpetuity, the time value of the project is zero 6/30/2014Anu Damodaran20 Political risk
    21. 21. METHODS IN INCORPORATION OF RISKS Associate local government with the project, insurance Shortening the payback period Raising the required IRR Adjusting cash flows to reflect the specific impact of a given risk Take and pay/ take or pay contracts, guarantees of loan 6/30/2014Anu Damodaran21
    22. 22. EVALUATION OF OVERSEAS PROJECTS – INFORMATION REQUIRED  Net Investment Outlay  Estimating Streams of Cash Benefits  Estimating Operating Cash Outflows  Salvage Value  Lifespan of the Projects  Restrictions on Transfer of Funds  Tax Laws  Exchange Rates  Required Rate of Return 6/30/2014Anu Damodaran22
    23. 23. 6/30/2014Anu Damodaran23
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