international capital budgeting.slides
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INTERNATIONAL
CAPITAL
BUDGETING
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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
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INCREASE
IN REVENUES
WHY NEW
PROJECTS
REDUCTION
IN
COSTS
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A FOREIGN PROJECT THAT IS
PROFITABLE WHEN VALUED ON
ITS OWN MAY NOT BE PROFITABLE
OTHERWISE.
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FOREIGN INVESTMENT DECISION PROCESS
MAY BE VIEWED AS AN INTEGRAL UNIT OF
MANY ELEMENTS THAT ARE INTERRELATED.
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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
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Search for Foreign Investment
* Profit Opportunities
* Tax Policy
* Diversification Strategies
* Environmental Forces
* Organisational Factors
* Drive by some High Ranking officials
inside a Company
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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.
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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.
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Cash Flow Analysis
* Tax Laws
* Import Duties
* Exchange Rate
* Sales Creation
* Cannibalisation (Loss to present
sales)
* Fees & Royalties
* Intangible benefits (learning)
* Exchange Rate
* Expropriation
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Cash Flow Analysis
Two sets of Cash Flows for Analysis
(a) One for the project itself
(b) One for the parent company
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Cash Flow DeterminationAt the Subsidiary Level
Sales Less : Cash Operating CostsLess : Management fees charged by parentsLess : Royalties, Licences, Brand charged by parentsLess : DepreciationLess : Amortisation of Technology transfer EBTEarnings Before Tax (EBT)Less : TaxesEarnings After Tax (EAT)Add :DepreciationAdd :AmortisationCash Flow After Taxes (CFAT)Add :Salvage Value & Recovery of WC of last year
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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
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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.
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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
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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.
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Risk Analysis
* ADJUSTMENT IN CASH FLOWS
* ADJUSTMENT IN DISCOUNT RATE
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IMPLEMENTATION
Control – Complete within established
guidelines.
Was or has the
Post Audits project been a
success
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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
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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.
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Adjusted Present Value
AdjustedPresentValue
PresentValue of the asset cash flows
PV of side effects
associated with
projects*
* At their respective discount rate to be discussed in last slide
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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
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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)