The slide gives you the overview of multinational capital budgeting and how it is calculated

2. How does domestic capital budgeting differ from
multinational capital budgeting?
How do incremental cash flows differ from total project
cash flows?
What is the difference between foreign project cash flows
and parent cash flows?
How does APV analysis differ from NPV analysis?
How is the capital budgeting analysis adjusted for the
additional economic and political risks?
What is real option analysis?

3. Several factors make budgeting for a foreign project more
complex
 Parent cash flows must be distinguished from project
 Parent cash flows often depend on the form of financing,
thus cannot clearly separate cash flows from financing
 Additional cash flows from new investment may in part or in
whole take away from another subsidiary; thus as stand
alone may provide cash flows but overall adds no value to
entire organization
 Parent must recognize remittances from foreign investment
because of differing tax systems, legal and political
constraints

4.  An array of non-financial payments can generate cash flows
to parent in form of licensing fees, royalty payments, etc.
 Managers must anticipate differing rates of national inflation
which can affect differing cash flows
 Use of segmented national capital markets may create
opportunity for financial gain or additional costs
 Use of host government subsidies complicates capital
structure and parent’s ability to determine appropriate
WACC
 Managers must evaluate political risk
 Terminal value is more difficult to estimate because
potential purchasers have widely divergent views

5.  NPV Analysis
 If Projects are independent, those with a positive NPV will be accepted while those with a negative NPV will be rejected
 It two projects are mutually exclusive, the project with the highest NPV greater than zero will be accepted.
 The discount rate, k, is the expected rate of return on projects of similar risk as the riskiness of the firm as a whole.
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6. Consistent with the goal of maximizing shareholder
wealth.
Focuses on cash flows rather than accounting profits.
Emphasizes the opportunity cost of money invested.
Obeys the additivity principle.

7. Only the additional cash flows generated by the
project are relevant.
The difference between total and incremental cash
flows arises from:
Cannibalization
Sales creation
Opportunity cost
Transfer prices
Fees and royalties

8. The base case is represented by the worldwide
corporate cash flows without the investment.
In a competitive world, the base case needs to be
adjusted for competitive behavior.
New product
New production technology
Intangible benefits

9. Project risks and financial structures vary by country,
production state, and position in the life cycle of the
project.
Rather than modifying the WACC, cash flows can be
discounted at an all-equity rate, k*.
Reflects only the riskiness of the project’s expected
future cash flows.
Abstracts from the project’s financial structure.
Can be viewed as the company’s cost of capital if it were
all-equity financed, that is, with zero debt.

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The all-equity rate is based on the CAPM:
k* = rf + β* (rm – rf)
β* is the all-equity or unlevered beta
A levered equity beta, βe, is unlevered using the
following equation:

11. The value of a project is equal to the sum of the
following components:
PV of after-tax project cash flows but before financing
costs discounted at k*.
PV of tax savings on debt financing discounted at the
before-tax dollar cost of debt, id.
PV of any savings or penalties on interest costs
associated with project-specific financing discounted at
the before-tax dollar cost of debt, id.

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Tt = tax savings in year t due to the specific financing
package
St = before-tax dollar value of interest subsidies
(penalties)
id = before-tax dollar cost of debt

13. Should cash flows be measured from the viewpoint of
the project or that of the parent?
Should the additional economic and political risks
that are uniquely foreign be reflected in cash flow or
discount rate adjustments?

14. Most firms evaluate foreign projects from both parent
and project viewpoints
The parent’s viewpoint analyses investment’s cash flows
as operating cash flows instead of financing due to
remittance of royalty or licensing fees and interest
payments
The parent’s viewpoint gives results closer to
traditional NPV capital budgeting analysis
Project valuation provides closer approximation of
effect on consolidated EPS

15. Project and parent cash flows can divergediverge significantly
due to:
Tax regulations
Exchange controls
Fees and royalties
Transfer pricing
Other factors

16. Stage1:
Project cash flows are computed from the subsidiary’s
perspective.
Stage 2:
Project cash flows to the parent are evaluated on the
basis of specific forecasts concerning the amount,
timing, and form of remittance.
Stage 3:
Account for the additional benefits and costs of the
project.

17. Estimating a project’s true profitability requires
various adjustments to the project cash flows:
Adjust for the effects of transfer pricing and fees and
royalties.
Adjust for global costs/benefits that are not reflected in
the project’s financial statements.
Cannibalization
Sales creation
Additional taxes
Diversification of production facilities and markets

18. Only after tax cash flows are relevant.
Actual taxes paid are a function of:
Time of remittance
Form of remittance
Foreign income tax rate
Withholding taxes
Tax treaties
Foreign tax credits

19. Computing the tax liabilities of foreign investments
assumes that:
The maximum amount of funds are available for
remittance each year.
The tax rate applied is the higher of the home or host
country rate.

20. Suppose that an affiliate will remit after-tax earnings of
$120,000 to its U.S. parent in the form of a dividend.
Assume the foreign tax rate is 20%, the withholding tax on
dividends is 4%, and excess foreign tax credits are
unavailable.
 What is the additional tax owed to the U.S. government?
 What is the marginal rate of additional taxation?

21. There are threethree main methods for incorporating the
additional political and economic risks into a foreign
investment analysis:
Shortening the payback period
Raising the required rate of return of the investment
Adjusting the cash flows to reflect the specific impact of
a given risk.
Uncertainty absorption
Adjusting the expected value of future cash flows

22. The analysis should also consider the appreciation or
depreciation of the US dollar.
Approach A:
 Convert nominal foreign currency cash flows into nominal
home currency terms.
 Discount those nominal cash flows at the nominal domestic
required rate of return.
Approach B:
 Discount the nominal foreign currency cash flows at the
nominal foreign currency required rate of return.
 Convert the resulting foreign currency present value into the
home currency using the current spot rate.

23. The preferred method is to adjust the cash flows of
the project to reflect the impact of a particular
political event on the present value of the project to
the parent.
The biggest risk is:
o Expropriation
o Blocked funds

24. Suppose a firm projects a $5 million perpetuity from an
investment of $20 million in Spain. If the required return
on this investment is 20%, how large does the probability
of expropriation in year 4 have to be before the investment
has a negative NPV? Assume that all cash flows occur at
the end of the year and that the expropriation, if it occurs,
will occur prior to the year 4 cash inflows or not at all.
There is no compensation in the event of expropriation.

25. DCF analysis cannot capture the value of the strategic
options, yet real option analysis allows this valuation.
Real option analysis includes the valuation of the
project with future choices such as:
 The option to defer
 The option to abandon
 The option to alter capacity
 The option to start up or shut down (switching)

26. Real option analysis treats cash flows in terms of
future value in a positive sense whereas DCF treats
future cash flows negatively (on a discounted basis).
The valuation of real options and the variables’
volatilities is similar to equity option math.
An expanded NPV rule consists of the traditional DCF
analysis plus the value of an option.