Lecture 14 - Multinational capital budgeting. This chapter’s objectives are to: To compare the capital budgeting analysis of an MNC’s subsidiary with that of its parent; to demonstrate how multinational capital budgeting can be applied to determine whether an international project should be implemented; and to explain how the risk of international projects can be assessed.
Lecture 14 Multinational Capital Budgeting Chapter Objectives To compare the capital budgeting analysis of an MNC’s subsidiary with that of its parent; To demonstrate how multinational capital budgeting can be applied to determine whether an international project should be implemented; and To explain how the risk of international projects can be assessed 14 - Subsidiary versus Parent Perspective • Should the capital budgeting for a multinational project be conducted from the viewpoint of the subsidiary that will administer the project, or the parent that will provide most of the financing? • The results may vary with the perspective taken because the net after-tax cash inflows to the parent can differ substantially from those to the subsidiary 14 - Subsidiary versus Parent Perspective • Such differences can be due to: Ô Tax differentials What is the tax rate on remitted funds? Ô Regulations that restrict remittances ¤ Excessive remittances The parent may charge its subsidiary very high administrative fees Ô Exchange rate movements 14 - Remitting Subsidiary Earnings to the Parent Cash Flows Generated by Subsidiary Corporate Taxes Paid to Host Government After-Tax Cash Flows to Subsidiary Retained Earnings by Subsidiary Cash Flows Remitted by Subsidiary After-Tax Cash Flows Remitted by Subsidiary Withholding Tax Paid to Host Government Conversion of Funds to Parent’s Currency Cash Flows to Parent Parent 14 - Subsidiary versus Parent Perspective • A parent’s perspective is appropriate when evaluating a project, since any project that can create a positive net present value for the parent should enhance the firm’s value • However, one exception to this rule occurs when the foreign subsidiary is not wholly owned by the parent 14 - Input for Multinational Capital Budgeting The following forecasts are usually required: Initial investment Consumer demand over time Product price over time Variable cost over time Fixed cost over time Project lifetime Salvage (liquidation) value 14 - Input for Multinational Capital Budgeting The following forecasts are usually required: 10 11 Restrictions on fund transfers Tax payments and credits Exchange rates Required rate of return 14 - Multinational Capital Budgeting • Capital budgeting is necessary for all long-term projects that deserve consideration • One common method of performing the analysis involves estimating the cash flows and salvage value to be received by the parent, and then computing the net present value (NPV) of the project 14 - Multinational Capital Budgeting • NPV = – initial outlay n + t =1 + cash flow in period t (1 + k )t salvage value (1 + k )n k = the required rate of return on the project n = project lifetime in terms of periods • If NPV > 0, the project can be accepted 14 - 10 • Source: Adopted from SouthWestern/Thomson Learning © 2006 14 - 11 ... payments and credits Exchange rates Required rate of return 14 - Multinational Capital Budgeting • Capital budgeting is necessary for all long-term projects that deserve consideration • One common... in terms of periods • If NPV > 0, the project can be accepted 14 - 10 • Source: Adopted from SouthWestern/Thomson Learning © 2006 14 - 11 ... Remitted by Subsidiary After-Tax Cash Flows Remitted by Subsidiary Withholding Tax Paid to Host Government Conversion of Funds to Parent’s Currency Cash Flows to Parent Parent 14 - Subsidiary versus