ifm project(2)

8/8/2019 Ifm Project(2)

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INTERNATIONAL PROJECT

APPRAISAL


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RECENT GLOBAL TRENDS

FDI has been the major driving force towardsglobalization

Cross border M&A have also added to the CAUSE

Acquisitions bring major benefit

1)Existing customers

2)Foothold in destination market

4)Niche technologies to the company


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Developing countries like India Reluctant in FDI In recent years , India has moved to moved to more

liberal policies.

RBI has been liberalizing overseas investment norms .

Till eighties, most of FDIs was between developedcountries.

In recent years, entrepreneurs from developingcountries will move to lesser developed countries.

Indian corporate are spreading their wings rapidly.


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EXAMPLES OF LIBEREALIZED RBI NORMS:

Hiked the overseas direct Investment limit from 200%of the net worth to 300% of net worth.

Hiked the limit on overseas portfolio investments from

25% to 35% of their net worth.

Allowed Indian residents to remit up to US$100000per financial yr, previously it was US$50000.

From US$3 billion, RBI has allowed Mutual funds to

invest fund of US$4 billion in overseas market.


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SOME OF THE APPROACHES TO VALUE

A DOMESTIC INVESTMENT


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ADJUSTED PRESENT VALUE(APV)

FRAMEWORK

Its a two step process:

1) Evaluate the project as if it is financed entirely by

equity .The rate of discount is the required rate of

return on equity corresponding to the risk class of

the project.

2) Add the present values of any cash flows arising

out of special financing features the rate of discount

should reflect the risk associated with each of the

cash flows.


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PROJECT APPRAISAL INTHE INTERNATIONAL

CONTEXT


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MAIN HURDLES DIFFERENTIATING A

FOREIGN PROJECT

EXCHANGE RATE AND CAPITAL MARKET SEGMENTATION

POLITICAL OR COUNTRY RISK

INTERNATIONAL TAXATION

BLOCKED FUNDS


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EXCHANGE RATE RISK AND CAPITAL

MARKET SEGMENTATION

Since cash flows from a foreign project are

in foreign currency and therefore subject to

forex risk.

How to incorporate this in project valuation?Also what is the appropriate cost of capital

when the host and home country forex

markets are not integrated?


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POLITICAL OR COUNTRY RISK

Assets allocated abroad are subject to risk ofappropriation or nationalization by the host country govt

.Also there may be changes in withholding taxes,

remittances by the subsidiary to the parent.

Hence the main issue lies in incorporating these risks in

evaluating the project??


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INTERNATIONAL TAXATION

In most of the cases there might be the situation ofwithholding taxes on dividends and other income remitted

to the parent.

In addition, the home country government may tax this

income in the hands of the parent.

If double taxation avoidance treaty is there ,the parent may

obtain special credit for the taxes abroad.

There is also a related issue of transfer pricing which may

enable the parent to furthur reduce the overall tax burden.


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BLOCKED FUNDS

Sometimes , a foreign project can become an attractiveproposal because the parent has some funds

accumulated in a foreign country which cant be taken

out .

Investing these funds locally in a subsidiary or a JV may

then represent a better use of blocked funds.


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STEP BY STEP APPROACH TO THE

EVALUATION OF FOREIGN PROJECT

Treat the project as branch operation of parent company. All cash flows generated by the project- belongs to the parent

company.

Consider , project is fully equity financed, wholly owned

subsidiary of parent, formed under host country laws, having a

distinct legal identity.

Focus on various financial arrangements between parent and

subsidiary.

Consider all means- how to increase cash flow transfers between

parent and subsidiary and how to minimize tax burden


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REASONS FORCONSIDERING INTRA-

CORPORATE FINANCING

FROM EXTERNAL FINANCING


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THE THREE REASONS!!!

1)Intra corporate financing effects can be

estimated separately from external financing.

2) The nature of internal financing arrangements is

sensitive to the particular features of the tax laws in

the host and home country3)It forces the company to keep in mind that intra-

corporate financing impinges only on the allocation

of the profits between the parent and the subsidiary

and not a net gain or loss.


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EXAMPLE:

Titus ltd is considering a proposal to set up a fully owned manufacturing andsales subsidiary in Zimbabwe to serve the African and Middle-eastern

markets as well as to make a foray into the European market . Proposed

Quartz plant in Zimbabwe

Intial inv=Z$ 50,000,000

Balance of Z$ 50,000,000 in a local bank from its earlier export sales .this

can be repatriated to India after paying 48% tax.Comparable watches imported from europe and japan are currently sold at

Z$180 per watch.

The operating cost are estimated to be

Materials : Z$120.00 per watch

Labour : Z$25.00 per watch

Selling and other expenses : Z$ 5.00 per watch


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OPTIONS APPROACH TO PROJECT

APPRAISAL

Discounted cash flow approach NPV or APV haveserious drawbacks.

Both ignore the various operational flexibilities .

They assume that all operational decisions are made

once for all at the start of the project. In many situations, the project sponsors have the

freedom to alter some features of the project.

Done due to changes in govt. policies, competitive

pressures etc.


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SOME FLEXIBILITIES ARE:

1. Start of the project may be delayed till more info aboutthe variable like demand, cost, exchange rates are

obtained.

Example-

development of oil field may be delayed till oil priceshardens.

Starting of foreign plant may be postponed till the

foreign currency stabilizes.


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2. The project may be abandoned if the demand or priceforecast turn into be over optimistic operating costs

shoots up.

It may be temporarily closed down and re start when

the market conditions improved.

Example-

copper mine can be closed down when the copper

prices are low and restarted when market conditions

improved.


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3. The operational scale of the project may be expandedor contracted depending upon whether demand turns

out to be more or less than initially envisioned.

4. An input or output mix may be changed or different

technology may be employed.


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In recent years, the theory of option pricing has beenapplied to project appraisal to take account of these

operational flexibilities.

Example- an option to abandon a project can be viewed

as a put option. the option to sell the project assets-

with a strike price equal to the liquidation value of

project.

Option to start a project at later date is considered as

call option.


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In many cases , these choices can be incorporatedand evaluated using a decision tree approach.

In other cases, option pricing model like black-scholes

model can be used


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THE PRACTICE OF CROSS BORDER

DIRECT INVESTMENT APPRAISAL Some surveys were done regarding problems

of appraising investment projects in foreign

countries.

Many participants use DCF methods with

some version of asset pricing model to

estimate the cost of capital but make

adjustments for political and exchange risks.


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PAPER BY- KECK, LEVENGOOD AND

LONGFIELD (1998)

Large majority practitioners use DCF in method ofvaluation

In case of less integrated markets (Sri Lanka, Mexico

etc), exchange risks, political risks, sovereign risks and

unexpected inflation- considered important risk

factors in addition to market risks.

For integrated markets like the US, the UK- global

market portfolio (a risk factor) is used frequently.


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INTERNATIONAL JOINT VENTURES

Most common form of cross border investment is jointventures and other forms of alliances.

Between firm of host country and foreign country.

2 or more partners join hands as they have synergies

They might have strengths that complement eachother- in technology, distribution , market access etc.

A joint venture expects to have gain over and above

the sum of individual firms


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G

ame-theoretic model of bargaining the synergygain should be split equally.

Can also be done by proportional sharing of project

cash flows.

Example- 2 partners, A brings 30% investmentsB brings 70% investments ,

so the cash flows should be shared in the

same proportion.

Above situation can change with different tax regimesand tax rates.

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