Transcript Chapter 14 - nubacad.com

14
Chapter
Multinational Capital Budgeting
Chapter Objectives

To compare the capital budgeting
analysis of an MNC’s subsidiary with that
of its parent;

To demonstrate how multinational capital
budgeting can be applied to determine
whether an international project should be
implemented; and

To explain how the risk of international
projects can be assessed.
14 - 2
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 provide most of the financing?
• The results may vary with the perspective
taken because the net after-tax cash
inflows to the parent can differ
substantially from those to the subsidiary.
14 - 3
Subsidiary versus Parent
Perspective
• Such differences can be due to:
¤
Tax differentials
What is the tax rate on remitted funds?
¤
Regulations that restrict remittances
¤
Excessive remittances
The parent may charge its subsidiary very
high administrative fees.
¤
Exchange rate movements
14 - 4
Remitting Subsidiary Earnings to the Parent
Cash Flows Generated at Subsidiary
Corporate Taxes
Paid to Host
Government
After-Tax Cash Flows at Subsidiary
Retained Earnings
by Subsidiary
Cash Flows Remitted by Subsidiary
After-Tax Cash Flows Remitted by Subsidiary
Withholding Tax
Paid to Host
Government
Conversion of Funds
to Parent’s Currency
Cash Flows to Parent
Parent
14 - 5
Subsidiary versus Parent
Perspective
• A parent’s perspective is appropriate when
evaluating a project, since any project that
can create a positive net present value for the
parent should enhance the firm’s value.
• However, one exception to this rule occurs
when the foreign subsidiary is not wholly
owned by the parent.
• So, the way to decide the project to be either
subsidiary perspective or Parent perspective
is look upon the share holder. If share holders
are from subsidiary country, it would be
subsidiary perspective unless otherwise.
14 - 6
Input for Multinational
Capital Budgeting
The following forecasts are usually required:
1. Initial investment
2. Consumer demand over time
3. Product price over time
4. Variable cost over time
5. Fixed cost over time
6. Project lifetime
7. Salvage (liquidation) value
14 - 7
Input for Multinational
Capital Budgeting
The following forecasts are usually required:
8. Restrictions on fund transfers
9. Tax payments and credits
10. Exchange rates
11. Required rate of return
14 - 8
Multinational
Capital Budgeting Techniques
• Capital budgeting is necessary for all
long-term projects that deserve
consideration.
• One common method of performing the
analysis involves estimating the cash
flows and salvage value to be received by
the parent, and then computing the net
present value (NPV) of the project.
14 - 9
Multinational
Capital Budgeting
• NPV = – initial outlay
n
+
S
t =1
cash flow in period t
(1 + k )t
+ salvage value
(1 + k )n
k = the required rate of return on the project
n = project lifetime in terms of periods
• If NPV > 0, the project can be accepted.
14 - 10
Example
• Spartan, Inc. is considering the development of a subsidiary in
Singapore that will manufacture and sell tennis rackets locally.
• Initial investment: 20 million Singapore dollars (S$) which is $10
million at $.50 per Singapore dollar. Project life: 4 years. Price and
demand: 1st yr, 2nd, 3rd, 4th yrs price S$ S$ 350, S$ 350, S$ 360, S$
380 and demand 60000, 60000, 100000,100000 units respectively.
• Costs: Variable cost per unit of 1st ,2nd, 3rd, 4th are S$ 200, S$ 200, S$
250, S$ 260.The expense of leasing extra office space is S$ 1 million
per year and other annual overhead expenses are expected to be
S$1 million per year.
• Exchange rate: Spot rate is $.50 which will be assumed same over
the years. Host country taxes on income earned by subsidiary: 20
percent tax rate on income. Also have withholding tax of 10%. And
the remitted fund will not be taxed further in US. Depreciation: at a
maximum rate of 2 million per year. Salvage Value: S$ 12 million.
Required rate of return: 15%.
14 - 11
Capital Budgeting Analysis: Spartan, Inc.
14 - 12
Capital Budgeting Analysis: Spartan, Inc.
14 - 13
Capital Budgeting Analysis
1.
2.
3.
4.
5.
6.
7.
8.
9.
10.
11.
12.
Period t
Demand
(1)
Price per unit
(2)
Total revenue
(1)(2)=(3)
Variable cost per unit
(4)
Total variable cost
(1)(4)=(5)
Annual lease expense
(6)
Other fixed annual expenses
(7)
Noncash expense (depreciation)
(8)
Total expenses
(5)+(6)+(7)+(8)=(9)
Before-tax earnings of subsidiary
(3)–(9)=(10)
Host government tax
tax rate(10)=(11)
After-tax earnings of subsidiary
(10)–(11)=(12)
14 - 14
Capital Budgeting Analysis
13.
14.
15.
16.
17.
18.
19.
20.
21.
22.
Period t
Net cash flow to subsidiary
(12)+(8)=(13)
Remittance to parent
(14)
Tax on remitted funds
tax rate(14)=(15)
Remittance after withheld tax
(14)–(15)=(16)
Salvage value
(17)
Exchange rate
(18)
Cash flow to parent
(16)(18)+(17)(18)=(19)
PV of net cash flow to parent
(1+k) - t(19)=(20)
Initial investment by parent
(21)
Cumulative NPV
SPVs–(21)=(22)
14 - 15
Factors to Consider in
Multinational Capital Budgeting
 Exchange rate fluctuations
Since it is difficult to accurately forecast
exchange rates, different scenarios can be
considered together with their probability
of occurrence.
14 - 16
Analysis Using Different Exchange Rate
Scenarios: Spartan, Inc.
14 - 17
Sensitivity of the
Project’s NPV to
Different
Exchange Rate
Scenarios:
Spartan, Inc.
14 - 18
Factors to Consider in
Multinational Capital Budgeting
 Inflation
Although price/cost forecasting implicitly
considers inflation, inflation can be quite
volatile from year to year for some
countries.
14 - 19
Factors to Consider in
Multinational Capital Budgeting
 Financing arrangement
Financing costs are usually captured by
the discount rate.
However, when foreign projects are
partially financed by foreign subsidiaries,
a more accurate approach is to separate
the subsidiary investment and explicitly
consider foreign loan payments as cash
outflows.
14 - 20
Factors to Consider in
Multinational Capital Budgeting
 Blocked funds
Some countries require that the earnings
generated by the subsidiary be reinvested
locally for at least a certain period of time
before they can be remitted to the parent.
14 - 21
Capital Budgeting with Blocked Funds: Spartan, Inc.
Assume that all funds are blocked until the subsidiary is sold.
14 - 22
Factors to Consider in
Multinational Capital Budgeting
 Uncertain salvage value
Since the salvage value typically has a
significant impact on the project’s NPV,
the MNC may want to compute the breakeven salvage value.
 Impact of project on prevailing cash flows
The new investment may compete with the
existing business for the same customers.
14 - 23
Factors to Consider in
Multinational Capital Budgeting
 Host government incentives
These should also be incorporated into
the analysis.
A low-rate host government loan or a
reduced tax rate offered to the subsidiary
will enhance periodic cash flow.
If the government subsidizes the initial
establishment of the subsidiary, the MNC’s
initial investment will be reduced.
14 - 24
Adjusting Project Assessment
for Risk
• When an MNC is unsure of the estimated
cash flows of a proposed project, it needs
to incorporate an adjustment for this risk.
• One method is to use a risk-adjusted
discount rate. The greater the uncertainty,
the larger the discount rate that should be
applied to the cash flows.
14 - 25
Adjusting Project Assessment
for Risk
• An MNC may also perform sensitivity
analysis or simulation using computer
software packages to adjust its evaluation.
• Sensitivity analysis involves considering
alternative estimates for the input
variables, while simulation involves
repeating the analysis many times using
input values randomly drawn from their
respective probability distributions.
14 - 26
Problem-1
• Brower, Inc., just constructed a manufacturing plant in
Ghana. The construction cost 9 billion Ghanaian cedi.
Brower intends to leave the plant open for three years.
During the three years of operation ,cedi cash flows are
expected to be 3 billion cedi,3 billion cedi and 2 billion cedi,
respectively. Operating cash flows will begin one year from
today and are remitted back to the parent at the end of each
year. At the end of the third year, Brower expects to sell the
plant for 5 billion cedi. Brower has a required rate of return
of 17%.It currently takes 8700 cedi to buy one US dollar,
and the cedi is expected to depreciate by 5 percent per
year.
a) Determine the NPV for this project .Should Brower build the
plant?
b) How would your answer change if the value of the cedi was
expected to remain unchanged from its current value of
8700 cedi per US over the course of the three years?
Should Brower construct the plant then?
14 - 27
Problem-2
• A project A project in South Korea requires an initial
invvestment of 2 billion South Korean Won. The Project is
expected to generate net cash flows to the subsidiary of 3
billion and 4 billion won in the two years of
operation,respectively. Thee project has no salvage value.
The current value of the won is 1100won per US dollar and
the value of the won is expected to remain constant over
the next two years.
A) What is the NPV of this project if the required rate of
return is 13 percent?
B) Repeat the question, except assume that the value of the
won is expected to be 1200 won per US dollar after two
yeas. Further assume that the funds are blocked and the
parent company will only be able to remit them back to the
united states in two years. How does this affect the NPV of
the project.
14 - 28