Nobody

can really guarantee the future. The best we can do is to size up the chances, calculate the risks involved, estimate our ability to deal with them and make our plans with confidence. HENRY FORD II

 MNCs

evaluate a direct foreign investment proposal using capital budgeting process but this Capital budgeting is different stand from domestic capital budgeting.

 Once

a firm has compiled a list of prospective investments, the next objective is to select that combination of projects that maximises the company s value to its shareholders.

 Multinationals

usually find their analysis complicated by a variety of problems that are rarely, if ever, encountered by domestic firms. Several such problems include:

Differences between project and parent company cash flow.  Foreign tax regulations  Expropriation  Blocked funds exchange rate changes and inflation  Project-specific financing Project Differences between the basic business risks of foreign and domestic projects.


A framework has to be developed that allows measuring, and reducing to a common denominator, the consequences of these complex factors on the desirability of the foreign investment opportunities.  This helps in comparing and evaluating projects on a uniform basis.


 Proper

capital budgeting for the MNC is necessary for all long-term longprojects that deserve consideration.  The projects may range from a small expansion of a subsidiary to creation of a new subsidiary.

The

basic question to be answered is should capital budgeting be addressed by the parent company or by the subsidiary?

Capital

Budgeting involves a thorough analysis of decision criteria and application of rules that enable managers to arrive at a decision.

The

rule of thumb is given an investment opportunity, should a project be accepted or not?

 The

value of foreign investments to the parent company considers the difference between project and parent cash flow. Hence, capital budgeting also considers this.

 Managers

need to understand the options available; to adjust the scope of a project, failing which, the project cash flow might be negatively biased. The options include:

Expanding

or contracting the

project Abandoning the project Employing new technologies Entering new lines of business

So, it is important to understand : I. BASIS OF CAPITAL BUDGETING I. ISSUES IN FOREIGN INVESTMENT ANALYSIS III. POLITICAL RISK ANALYSIS IV.GROWTH OPTIONS AND PROJECT EVALUATION

BASICS OF CAPITAL BUDGETING A. Basic Criterion: Net Present Value B.Net Present Value Technique: 1. Definition The present value of future cash flows, discounted at the project s cost of capital less the initial net cash outlay.


Most important property of NPV technique: -focus on cash flows with respect to shareholder wealth 4. NPV obeys value additive principle: the NPV of a set of projects is the sum of the individual project NPV .
3.

C. International Cash Flows 1.Important principle when estimating: Incremental basis 2. Distinguish total from incremental flows to account for a. cannibalization b. sales creation c. opportunity cost d. transfer pricing e. fees and royalties


Getting the base case correct Rule of thumb: Incremental cash flows
 3.

Incremental Cash flows without

Global Global = corporate - flow cash flow with project project

4.Intangible Benefits a. Valuable learning experience b. Broader knowledge base

II. ISSUES IN FOREIGN INVESTMENT ANALYSIS

II. TWO ISSUES IN FOREIGN INVESTMENT ANALYSIS A. Issue #1 Parent v. Project Cash Flow -the cash flows from the project may differ from those remitted to the parent 1. Relevant cash flows become quite important

ISSUES IN FOREIGN INVESTMENT ANALYSIS

2.

Three Stage Approach to simplify project evaluation : a. compute subsidiary s project cash flows b. evaluate the project to the parent c. incorporate the indirect effects

ISSUES IN FOREIGN INVESTMENT ANALYSIS

3.Estimating Incremental Project Flows What is the true profitability of the project? a.Adjust for tax effects of a.Adjust 1.) transfer pricing 2.) fees and royalties

4.Intangible Benefits a. Valuable learning experience b. Broader knowledge base

ISSUES IN FOREIGN INVESTMENT ANALYSIS

4.Tax Factors: determine the amount and timing of taxes paid on foreign-source income. foreign-

ISSUES IN FOREIGN INVESTMENT ANALYSIS

B. Issue #2 How to adjust for increased economic and political risk of project? 1.Three Methods of Economic and Political Risk Adjustments: a.Shortening minimum payback period a.Shortening b. Raising required rate of return c. Adjusting cash flows


ISSUES IN FOREIGN INVESTMENT ANALYSIS

2.Accounting for Exchange Rate and Price Changes (inflationary) Two stage procedure: a.Convert nominal foreign cash flows into a.Convert home currency terms b. Discount home currency flows at domestic required rate of return.

III. POLITICAL RISK ANALYSIS

III. POLITICAL RISK ANALYSIS A.Political risks can be incorporated into an NPV analysis by - adjusting expected project cash flows to reflect the risks.


POLITICAL RISK ANALYSIS

B. EXPROPRIATION - the extreme form of political risk C.BLOCKED FUNDS

IV. GROWTH OPTIONS AND PROJECT EVALUATION



IV. GROWTH OPTIONS AND PROJECT EVALUATION A.Options: 1.an important component of many investment decisions 2. ignoring options will understate the NPV of that investment

Finally to conclude, we can say that capital budgeting in an MNC is a complex process which has to be evaluated after a thorough logical analysis of all the options and issues concerned.