issues in foreign investment
TRANSCRIPT
ISSUES IN FOREIGN INVESTMENT ANALYSIS
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CAPITAL BUDGETING
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Capital budgeting to a company is what buying stocks or bonds is to individuals
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• Estimate cash flows (inflows & outflows).
• Assess risk of cash flows.• Determine appropriate discount
rate (r = WACC) for project.• Evaluate cash flows. (Find NPV or
IRR etc.)• Accept/Reject Decision
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EVALUATION METHODS
Payback (Payback Period = Cost of Project / Annual Cash Inflows)
Discounted Payback (DCF = Actual Cash flows / [1 + i]^n)
Internal Rate of Return (IRR) 0 = P0 + P1/(1+IRR) + P2/(1+IRR)2 + P3/(1+IRR)3 + . . . +Pn/(1+IRR)n
Modified Internal Rate of Return (MIRR) = number of periods (√ Sum of Terminal Cash Flows other than Initial Investment / Initial Investment ) − 1
Profitability Index (PI) = Present Value of Future Cash Flows /Initial Investment Required
Net Present Value (NPV)
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Project’s Cash Flows (CFt)
Marketinterest
rates
Project’s business
risk
Marketrisk
aversion
Project’sdebt/equity
capacityProject’s risk-
adjustedcost of capital
(r)
The Big Picture:The Net Present Value of a
Project
NPV = + + ··· + − Initial cost
CF1
CF2
CFN
(1 + r )1 (1 + r)N(1 + r)2
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CAPITAL BUDGETING FOR FOREIGN PROJECTS
MORE COMPLICATIONS
Multiple currencies
Multiple tax rates
Multiple tax systems
Exchange rate fluctuations
Capital flow restrictions
Project specific subsidization – host government
Project specific penalties – host government
Valuing and investing – local currency of host vs domestic currency of parent
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Issues in Foreign Investment Analysis
1. Parent Vs. Project Cash Flows
2. Tax Issue
3. Exchange Control
4. Subsidized Finance
5. Knock-on Effects
6. Exchange Rate Changes and Inflation
7. Loss due to lost Exports
8. International Diversification Benefits
9. Political Risk
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1. Project cash flows computed from subsidiaries side (separate entity)
2. Specific forecasts concerning the amounts, timing of distributable cash expenses that will be incurred in the process of transfer from parent side
3. Indirect benefits and costs , such as an increase or decrease in export sales by another partner
Parent VS Project
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Host country and home country tax
Earnings - host country tax net + withholding tax (distribution)
Earnings - further taxed in home country
After tax cash flows
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Repatriation of earnings to parent
Government and
international
agenciesAdd
value of loan to project at the time of investm
ent decision
Financing below market rates
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There are knock-on effects from one country to another. For example, investment in a subsidiary in country X affects cash flows of a subsidiary in country Y
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For proper evaluation of expected cash flows from overseas project first the impact of offsetting inflation and exchange rate exchanges needs to be removed
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Loss of exports
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Take care of in case of marginal project or a project that is not acceptable on the basis of merits, benefits should be quantified and taken care of
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RISK ANALYSIS
Political risk
Financial risk (Exchange rate
Risk, Inflation/Purchasing power
risk, Interest rate risk)
Other risks (Cost overruns and bad
management)
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Expropriation element contributes to divergence in cash flows of the
project and cash flows available to the parent company
In case of funds to be blocked in perpetuity, the time value of the
project is zero
Political risk
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METHODS IN INCORPORATION OF RISKS
Associate local government with the
project, insurance
Shortening the payback period
Raising the required IRR
Adjusting cash flows to reflect the specific impact of a
given risk
Take and pay/ take or pay contracts, guarantees of loan
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EVALUATION OF OVERSEAS PROJECTS – INFORMATION REQUIRED
Net Investment Outlay
Estimating Streams of Cash Benefits
Estimating Operating Cash Outflows
Salvage Value
Lifespan of the Projects
Restrictions on Transfer of Funds
Tax Laws
Exchange Rates
Required Rate of Return
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