This document discusses international capital budgeting and the foreign investment decision process. It outlines several key steps in the process, including assessing the political climate of the host country, performing a cash flow analysis from the perspective of both the subsidiary and parent company, determining the required rate of return or cost of capital, evaluating projects using techniques like NPV and IRR, selecting projects, analyzing risk, implementing projects, and conducting post audits. International capital budgeting involves additional complexities over domestic capital budgeting, such as accounting for political risk, exchange rate changes, and cash flows to both the subsidiary and parent company.

1. INTERNATIONAL
CAPITAL
BUDGETING

2. 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

3. INCREASE
IN REVENUES
WHY NEW
PROJECTS
REDUCTION
IN COSTS

4. A FOREIGN PROJECT THAT IS PROFITABLE
WHEN VALUED ON ITS OWN MAY NOT BE
PROFITABLE OTHERWISE.

5. FOREIGN INVESTMENT DECISION PROCESS MAY BE
VIEWED AS AN INTEGRAL UNIT OF MANY ELEMENTS
THAT ARE INTERRELATED.

6. 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

7. Search for Foreign Investment
*
Profit Opportunities
*
Tax Policy
*
Diversification Strategies
*
Environmental Forces
*
Organisational Factors
*
Drive by some High Ranking officials inside a
Company

8. 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.

9. 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.

10. Cash Flow Analysis
*
Tax Laws
*
Import Duties
*
Exchange Rate
*
Sales Creation
*
Cannibalisation (Loss to present sales)
*
Fees & Royalties
*
Intangible benefits (learning)
*
Exchange Rate
*
Expropriation

11. Cash Flow Analysis
Two sets of Cash Flows for Analysis
(a)
One for the project itself
(b)
One for the parent company

12. 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

13. 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

14. 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.

15. 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

16. 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.

17. Risk Analysis
*
ADJUSTMENT IN CASH FLOWS
*
ADJUSTMENT IN DISCOUNT RATE

18. IMPLEMENTATION
Control – Complete within established guidelines.
Was or has the
Post Audits
project been a
success

19. 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

20. 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.

21. 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

22. Additional Issues Involved in CrossBorder 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

23. Additional Issues Involved in CrossBorder 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)