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)
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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
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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
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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
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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
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13. Host country and home
country tax
Earnings - host country tax
net + withholding tax
(distribution)
Earnings - further taxed in
home country
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After tax cash flows
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. 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
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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
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. RISK ANALYSIS
Political risk
Financial risk (Exchange rate
Risk, Inflation/Purchasing power
risk, Interest rate risk)
Other risks (Cost overruns and bad
management)
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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
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Political risk
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
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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
