Nobody can really guarantee the future. The best we can do is size up the chances, calculate the risks involved, estimate our ability to deal with them, and then make our plans with confidence. --- Henry Ford - II
A FOREIGN PROJECT THAT IS PROFITABLE WHEN VALUED ON ITS OWN MAY NOT BE PROFITABLE OTHERWISE.
FOREIGN INVESTMENT DECISION PROCESS MAY BE VIEWED AS AN INTEGRAL UNIT OF MANY ELEMENTS THAT ARE INTERRELATED.
Foreign Investment Decision Process * The decision to search for foreign investment * An assessment of the political climate in the host country * Examination of the overall strategy * Cash Flow Analysis * Required Rate of Return * Economic Evaluation * Selection * Risk Analysis * Implementation * Expenditure Control * Post Audit
Search for Foreign Investment * Profit Opportunities * Tax Policy * Diversification Strategies * Environmental Forces * Organisational Factors * Drive by some High Ranking officials inside a Company
Political Climate * Host country gives priority to projects that reduce the country’s need for imports. * Political actions such as exchange controls and discrimination, adversely affect company operations.
Company’s Overall Strategy The analyst must assess the usefulness of each alternative within the company’s overall strategy to determine how foreign operations may perpetuate current strengths or offset weaknesses.
Cash Flow Analysis Two sets of Cash Flows for Analysis (a) One for the project itself (b) One for the parent company
Cash Flow Determination At the Subsidiary Level Sales Less : Cash Operating Costs Less : Management fees charged by parents Less : Royalties, Licences, Brand charged by parents Less : Depreciation Less : Amortisation of Technology transfer EBT Earnings Before Tax (EBT) Less : Taxes Earnings After Tax (EAT) Add : Depreciation Add : Amortisation Cash Flow After Taxes (CFAT) Add : Salvage Value & Recovery of WC of last year
Cash Inflows to the Parent * Dividend Received * Interest Received * Management Fees * Royalties, Licences, Brands etc. * Gains due to transfer price adjustment * Terminal Cash Flows – net of all types of taxes – sums not received because of exchange control * Increase in cash profits (after taxes) or less decrease in cash profits
Cost of Capital Discount Rate – Required Rate – Minimum Rate The cost of capital is in effect the MAGIC NUMBER used to decide whether a proposed foreign investment will increase or decrease the firms stock price.
Economic Evaluation Once cash flows and cost of capital are known – process of evaluating investment projects. * Pay back period * ARR * NPV * IRR Which is Good
Selection * Accept – Reject decision * Mutually Exclusive Choice * Capital Rationing Adjusted Present Value : PV Technique – Discounts different cash flows at different rates – depending upon risk associated with each cash flow.
Risk Analysis * ADJUSTMENT IN CASH FLOWS * ADJUSTMENT IN DISCOUNT RATE
IMPLEMENTATION Control – Complete within established guidelines. Was or has the Post Audits project been a success
What makes International Capital Budgeting different from domestic Capital Budgeting * Project Cash Flows and Cash Flows to the Parent Company * Factor of Political Risk * Inflation & Exchange Rate changes
Financial Tools No doubt Financial Tools such as pay back, NPV or IRR can be used. But considering the additional issues involved that affect both the cash flows and the risk (discount rate) make these techniques insufficient.
Adjusted Present Value Adjusted Present Value Present Value of the asset cash flows PV of side effects associated with projects* * At their respective discount rate to be discussed in last slide
Additional Issues Involved in Cross-Border Projects * Home country or host country whose perspective be considered * Blocked Funds * Loss due to lost exports * Restrictions on Repatriation * Taxation * Effect on Borrowing capacity * Concessional Loan * Depreciation
Additional Issues Involved in Cross-Border Projects Discount Rates to be used for different cash flows: * Cash flows from projects (cost of equity) * Depreciation (risk free rate) * Borrowing capacity (risk free rate) * Concessional Loan (competitive market rate host country)