INTERNATIONAL

CAPITAL

BUDGETING

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

INCREASE

IN REVENUES

WHY NEW

PROJECTS

REDUCTION

IN

COSTS

A FOREIGN PROJECT THAT IS

PROFITABLE WHEN VALUED ON

ITS OWN MAY NOT BE PROFITABLE

OTHERWISE.

FOREIGN INVESTMENT DECISION PROCESS

MAY BE VIEWED AS AN INTEGRAL UNIT OF

MANY ELEMENTS THAT ARE INTERRELATED.

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

Search for Foreign Investment

* Profit Opportunities

* Tax Policy

* Diversification Strategies

* Environmental Forces

* Organisational Factors

* Drive by some High Ranking officials

inside a Company

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.

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.

Cash Flow Analysis

* Tax Laws

* Import Duties

* Exchange Rate

* Sales Creation

* Cannibalisation (Loss to present

sales)

* Fees & Royalties

* Intangible benefits (learning)

* Exchange Rate

* Expropriation

Cash Flow Analysis

Two sets of Cash Flows for Analysis

(a) One for the project itself

(b) One for the parent company

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

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

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.

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

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.

Risk Analysis

* ADJUSTMENT IN CASH FLOWS

* ADJUSTMENT IN DISCOUNT RATE

IMPLEMENTATION

Control – Complete within established

guidelines.

Was or has the

Post Audits project been a

success

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

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.

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

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

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)