Internationalcapitalbudgeting Slides 110216232856 Phpapp01

8/12/2019 Internationalcapitalbudgeting Slides 110216232856 Phpapp01

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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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Political Climate

* Host country gives priority to projects that

reduce the countrysneed for imports.

* Political actions such as exchange controls and

discrimination, adversely affect company

operations.


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Companys Overall Strategy

The analyst must assess the usefulness of each

alternative within the companys 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

SalesLess : Cash Operating Costs

Less : Management fees charged by parents

Less : Royalties, Licences, Brand charged by parents

Less : DepreciationLess : Amortisation of Technology transfer EBT

Earnings Before Tax (EBT)

Less : Taxes

Earnings After Tax (EAT)Add : Depreciation

Add : Amortisation

Cash 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 Flowsnet of all types of taxes

sums not received because of exchangecontrol

* Increase in cash profits (after taxes) or less

decrease in cash profits


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Cost of Capital

Discount RateRequired RateMinimum 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

* AcceptReject 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

ControlComplete 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 theasset cash

flows

PV of side

effectsassociated

withprojects*

* 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)

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Internationalcapitalbudgeting Slides 110216232856 Phpapp01