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    Webinar 12

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    Hélio Julião Ngove

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    Webinar 12

    Uploaded by

    Hélio Julião Ngove
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    13 views20 pages

    Webinar 12

    Uploaded by

    Hélio Julião Ngove

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    © All Rights Reserved
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    Course International Financial Management

    Topic Concepts of International Capital Budgeting


    Faculty Ujwal M S
    Learning Objectives

    At the end of this session, you will be able to:

    ➢ Learning Objective 1: Introduction to Capital Budgeting Decision

    ➢ Learning Objective 2: Significance & Process of Capital Budgeting Decision

    ➢ Learning Objective 3: To compare capital budgeting analysis of an MNC’s


    subsidiary with that of its parent
    INTERNATIONAL CAPITAL BUDGETING DECISION
    INTRODUCTION
    Multinational corporations (MNCs) evaluate international
    projects by using multinational capital budgeting, which
    compares the benefits and costs of these projects.

    More specifically, MNCs determine whether an international


    project is feasible by comparing the present value of that
    project’s expected future cash flows to the initial investment
    that would be necessary for that project. This type of
    evaluation for international projects is similar to the
    evaluation of domestic projects.

    However, special circumstances of international projects


    that affect the expected future cash flows or the discount
    rate used to discount cash flows make multinational capital
    budgeting more complex than domestic capital budgeting.
    INTERNATIONAL CAPITAL BUDGETING DECISION

    Given that many MNCs spend more than $100 million


    per year on international projects, multinational capital
    budgeting is a critical function.

    Many international projects are irreversible and cannot


    be easily sold to other corporations at a reasonable
    price.

    Financial managers must understand how to apply


    capital budgeting to international projects so they can
    maximize the value of the MNC. This chapter provides
    an overview of the capital budgeting process and
    identifies the type of information used.
    INTERNATIONAL CAPITAL BUDGETING DECISION
    MEANING:
    • CBD is decision relating to the investment of funds on capital
    projects, capital investment or capital expenditure.
    • Capital budgeting decisions is nothing but investment decisions.
    • It’s an expenditure whose benefits are expected to be received
    over a period of time, say, exceeding a year.
    • Hence capital budgeting is investment in long term assets.

    Examples:
    Investment in permanent assets
    Replacement of permanent assets
    Investment in expansion & improvement in fixed or permanent
    assets
    Investment in research & product development
    INTERNATIONAL CAPITAL BUDGETING DECISION
    DEFINITIONS:
    ‘’Capital budgeting is the long term planning for making &
    financing proposed capital outlay” – CHARLES T HORNGREN

    ‘’Capital budgeting refers to the total process of generating,


    evaluating, selecting & following up on capital expenditure
    alternatives “– GITMAN L.J

    Thus, Capital budgeting may be defined as “ the firms decisions to


    invest its current funds most efficiently in the long term assets &
    anticipation of an expected flow of benefit over a series of years”
    SIGNIFICNCE OF CAPITAL BUDGETING DECISIONS:
    I. GROWTH

    II. HUGE INVESTMENT

    III. INVOLVE RISK

    IV. IRRIVERSIBLE DECISIONS

    V. EFFECT ON OTHER PROJECTS

    VI. DIFFICULTIES OF INVESTMENT DECISIONS


    STEPS/ PROCESS OF CAPITAL BUDGETING
    1. Project Planning/Generation:
    Investment proposals are the first step in capital budgeting. Taking up investments in a business
    can be motivated by a number of reasons. There could be the addition or expansion of a product
    line. An increase in production or a decrease in production costs could also be suggested.

    2. Project Evaluation:
    It mainly consists of selecting all criteria necessary for judging the need for a proposal. In order to
    maximize market value, it has to match the company's mission. It is crucial to consider the time
    value of money here.
    In addition to estimating the benefits and costs, you should weigh the pros and cons associated
    with the process. There could be a lot of risks involved with the total cash inflows and outflows.
    This needs to be scrutinized thoroughly before moving ahead.
    STEPS/ PROCESS OF CAPITAL BUDGETING
    3. Project Selection:
    After the project has been finalized, the other components need to be attended to. These include the
    acquisition of funds which can be explored by the finance department of the company. The
    companies need to explore all the options before concluding and approving the project. Besides, the
    factors like viability, profitability, and market conditions also play a vital role in the selection of the
    project.

    4. Project Execution:
    Once the project is implemented, now come the other critical elements such as completing it in the
    stipulated time frame or reduction of costs. Hereafter, the management takes charge of monitoring
    the impact of implementing the project.

    5. Follow up Of Project/ Project Control:


    This involves the process of analyzing and assessing the actual results over the estimated outcomes.
    This step helps the management identify the flaws and eliminate them for future proposals.
    TYPES OF CAPITAL INVESTMENT PROJECTS/DECISIONS
    1. Independent Projects:
    - Projects which do not compete with one another
    - Acceptance of one project does not prevent the possibility of acceptance of another project
    - Project is accepted when expected return is more than predetermined rate of return

    2. Dependent Projects:
    - This type of project is also called as contingent project (project that can be accepted only if one or more projects is
    accepted first)
    - Selection of one project requires to undertake one or more other project
    - Contingent project makes to select a group of project as a single project

    3. Mutually Exclusive Projects:


    - These are projects which compete with each other in such a way that the acceptance of one project will exclude the
    acceptance of other
    Example: a company has option to buy a component from an outsider or manufacturer within the firm.
    In this situation, the company may take most profitable decision based on purchase price or manufacturing cost
    whichever is less
    TECHNIQUES OF CAPITAL BUDGETING

    I. TRADITIONAL TECHNIQUES-
    a. Payback period method
    b. Average rate of return method (ARR)

    II. MODERN / DISCOUNTED CASH FLOW TECHNIQUES –


    a. Net present value (NPV)
    b. Internal rate of return (IRR)
    c. Profitability index
    d. Discounted payback period

    VIDEO: https://www.investopedia.com/articles/financial-theory/11/corporate-project-valuation-methods.asp
    FORMAT OF CASH INFLOW AFTER TAXES
    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 finance the project?

    The results can vary with the perspective taken because the net after-tax cash inflows to the
    parent can differ substantially from those to the subsidiary.

    Normally, multinational capital budgeting should be based on the parent’s perspective. Some
    projects might be feasible for a subsidiary but not feasible for the parent, since net after-tax cash
    inflows to the subsidiary can differ substantially from those to the parent. Such differences in
    cash flows between the subsidiary versus parent can be due to several factors, some of which are
    discussed here.
    SUBSIDIARY VERSUS PARENT PERSPECTIVE
    Net cash flow differences can be due to:
    a. Tax Differentials:
    If the earnings due to the project will someday be remitted to the parent, the MNC needs to consider how the
    parent’s government taxes these earnings. If the parent’s government imposes a high tax rate on the remitted
    funds, the project may be feasible from the subsidiary’s point of view, but not from the parent’s point of view

    b. Restrictions on Remitted Earnings:


    Host governments may impose restrictions on remitted earnings by subsidiaries. Consider a potential project to
    be implemented in a country where host government restrictions require that a percentage of the subsidiary
    earnings remain in the country. Since the parent may never have access to these funds, the project is not
    attractive to the parent, although it may be attractive to the subsidiary.

    c. Exchange Rate Movements:


    When earnings are remitted to the parent, the amount received by the parent is influenced by the existing
    exchange rate. Therefore, a project that appears to be feasible to the subsidiary may not be feasible to the
    parent if the subsidiary’s currency is expected to weaken substantially over time.
    PROCESS OF REMITTING SUBSIDIARY EARNINGS TO THE PARENT
    INPUT FOR MULTINATIONAL CAPITAL BUDGETING
    Capital budgeting for the MNC is necessary for all long-term projects that deserve
    consideration. The projects may range from a small expansion of a subsidiary division to the
    creation of a new subsidiary. Regardless of the long-term project to be considered, an MNC will
    normally require forecasts of the financial characteristics that influence the initial investment
    or cash flows of the project. Each of these characteristics is briefly described here:

    ❖Initial investment
    ❖Price and consumer demand
    ❖Costs
    ❖Tax laws
    ❖Remitted funds
    ❖Exchange rates
    ❖Salvage (liquidation) value
    ❖Required rate of return
    MULTINATIONAL CAPITAL BUDGETING EXAMPLE
    This section illustrates how multinational capital budgeting can be applied. It
    begins with assumptions that simplify the capital budgeting analysis. Then,
    additional considerations are introduced to emphasize the potential complexity of
    such an analysis.

    EXAMPLE: Spartan, Inc., is considering the development of a subsidiary in


    Singapore that would manufacture and sell tennis rackets locally. Spartan’s
    financial managers have asked the manufacturing, marketing, and financial
    departments to provide them with relevant input so they can apply a capital
    budgeting analysis to this project.
    In addition, some Spartan executives have met with government officials in
    Singapore to discuss the proposed subsidiary.
    FACTORS TO CONSIDER IN MULTINATIONAL CAPITAL BUDGETING

    The example of Spartan, Inc., ignored a variety of factors that may affect the
    capital budgeting analysis, such as:

    • Exchange rate fluctuations


    • Inflation
    • Financing arrangement
    • Blocked funds
    • Uncertain salvage value
    • Impact of project on prevailing cash flows
    • Host government incentives
    Summary

    Key points discussed in this session:

    ➢ The Concept of Capital Budgeting Decision

    ➢ Perspective related to decision between the Parent company with its Subsidiary

    ➢ Scenario based illustration along with the other factors which should consider while taking
    decisions
    References
    Book References:
    ➢ International Finance: Theory and Policy, Global Edition-Krugman Paul R; Obstfeld Maurice; Melitz J Marc
    ➢ International Financial Management, Eleventh Edition by Jeff Madura
    ➢ International Finance: Fourth Edition by Maurice D. Levi
    ➢ International Financial Management, Second Edition by Geert Bekaert, Robert Hodrick

    E-References:
    ➢ https://www.investopedia.com/articles/financial-theory/11/corporate-project-
    valuation-methods.asp

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