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International Financial Management

Notes and is usually recommended by finance managers. There is generally more information on the
specific impact of a given risk on a project’s cash flows than on its discount rate.

Financing Arrangement

In some cases, the governments of countries are willing to provide loans at subsidized rates so
as to stimulate investment in specific sectors. The value of a project will then be determined by
the manner in which it is financed. For example, many times, international agencies in order to
promote cross border trade finance at below market rates. In the case of subsidized financing, it
is important to determine, if the subsidized financing is separable or not from the project. When
the subsidized financing is inseparable from the project, the value of the loan should be added
to that of the project in making the investment decision. When subsidized financing is separable
from the project, the additional value from the subsidized financing should not be allocated to
the project.

Notes 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.

Blocked Funds

Blocked Funds are cash flows generate by a foreign project that cannot be immediately transferred
to the parent, usually because of exchange controls imposed by the government of the country
in which the funds are held. 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. Blocked funds cause a discrepancy between the project value from the parent’s and local
perspective. Also, this can possibly affect the accept/reject decision for a project.

Inflation

The impact of inflation on the parent’s and subsidiary’s cash flows can be quite volatile from
year to year for some countries. It may cause the currency to weaken and hence influence a
project’s cash flows. Also, inaccurate inflation forecast by a country, can lead to inaccurate cash
flow forecasts. Thus, MNCs cannot afford to ignore the impact of inflation on the cash flows.

Uncertain Salvage Value

The salvage value of a project has an important impact on the NPV of the project. When the
salvage value is uncertain, the cash flows will not be accurate and the MNC may need to
calculate various possible outcomes for the salvage value and estimate the NPV based on each
possible outcome. The feasibility of the project may then depend upon the present value of the
salvage value.

Self Assessment

Fill in the blanks:
1. Multinational firms investing abroad are exposed to foreign exchange ………………….

2. Where there are restrictions on the repatriation of income, substantial differences exist
between project cash flows and cash flows received by the …………………… firm.

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