© 2011, 2010 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. International Financial Management Abridged 10 th Edition by Jeff Madura 1

© 2011, 2010 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. 14 Multinational Capital Budgeting Chapter Objectives This chapter will: A. Compare the capital budgeting analysis of an MNC’s subsidiary versus its parent B. Demonstrate how multinational capital building can be applied to determine whether an international project should be implemented C. Explain how the risk of international projects can be assessed. 2

© 2011, 2010 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Subsidiary versus Parent Perspective 1.Tax Differentials: different tax rates may make a project feasible from a subsidiary’s perspective, but not from a parent’s perspective. 2.Restricted Remittances: governments may place restrictions on whether earnings must remain in country. 3.Excessive Remittances: if the parent company charges fees to the subsidiary, then a project may appear favorable from a parent perspective, but not from a subsidiary’s perspective. 4.Exchange Rate Movements: earnings converted to the currency of the parent company will be affected by exchange rate movements.

© 2011, 2010 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Exhibit 14.1 Process of Remitting Subsidiary Earnings to Parent 4

© 2011, 2010 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Input for Multinational Capital Budgeting 1.Initial investment 2.Price and consumer demand 3.Costs 4.Tax laws 5.Remitted funds 6.Exchange rates 7.Salvage values 8.Required rate of return

© 2011, 2010 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Example: Spartan, Inc. 1.Initial investment: a.S$ 20 million 2.Price and consumer demand: a.Year 1 and 2: 60,000 S$350/unit b.Year 3: 100,000 S$360/unit c.Year 4: 100,000 S$380/unit 3.Costs a.Variable costs: Years 1 and 2 of S$200/unit, Year 3 of S$250/unit, Year 4 of S$260/unit b.Fixed costs: S$2 million per year 4.Tax laws a.20 percent income tax 5.Remitted funds a.10 percent withholding tax on remitted funds 6.Exchange rates a.Spot exchange rate of $0.50 for Singapore dollar 7.Salvage values a.S$12 million 8.Required rate of return a.15 percent

© 2011, 2010 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Calculation of NPV Where: IO = initial outlay (investment) CF t = cash flow in period t SV n = salvage value k = required rate of return on the project n = lifetime of the project (number of periods)

© 2011, 2010 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Spartan, Inc. NPV = $2,229,867

© 2011, 2010 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Other Factors to Consider 1.Exchange rate fluctuations 2.Inflation 3.Financing arrangement 4.Blocked funds 5.Uncertain salvage value 6.Impact of project on prevailing cash flows 7.Host government incentives 8.Real options 9

© 2011, 2010 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Other Factors: Exchange Rate Fluctuations Exhibit 14.4 Sensitivity of the Project’s NPV to Different Exchange Rate Scenarios: Spartan, Inc. 10

© 2011, 2010 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Other Factors: Inflation 1.Should affect both costs and revenues 2.Exchange rates of highly inflated countries tend to weaken over time

© 2011, 2010 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Other Factors: Financing Arrangement 1.Subsidiary financing 2.Parent company financing 3.Financing with other subsidiaries’ retained earnings

© 2011, 2010 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Other Factors: Blocked Funds 1.May include requirements that earnings be reinvested locally rather than repatriated.

© 2011, 2010 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Other Factors: Uncertain Salvage Value 1.Consider scenario analysis to estimate NPV at various salvage values 2.Consider estimating break-even salvage value at zero NPV

© 2011, 2010 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Other Factors: Impact of Project on Prevailing Cash Flows 1.Impact can be favorable if sales volume of parent increases following establishment of project. 2.Impact can be unfavorable if existing cash flows decline following establishment of project.

© 2011, 2010 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Other Factors: Host Government Incentives 1.Low-rate host government loans 2.Reduced tax rates for subsidiary 3.Government subsidies of initial investment

© 2011, 2010 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Other Factors: Real Options 1.Opportunity to obtain or eliminate real assets 2.Value is influenced by: a.Probability that real option will be exercised b.NPV that will result from exercising the real option

© 2011, 2010 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use. Adjusting Project Assessment for Risk 1.Risk-adjusted discount rate 2.Sensitivity analysis 3.Simulation