Page 224 - DMGT549_INTERNATIONAL_FINANCIAL_MANAGEMENT

Unit 13: Cross-border Capital Budgeting

3. If the opportunity cost of the blocked funds is zero the entire amount released for the Notes
project should be considered as a reduction in the …………………… investment.
4. The cash flows that are remitted to the parent consist of both …………………… cash flows
and financial cash flows.
5. Another important dimension in multinational capital budgeting is whether to adjust
cash flows or the discount rate to account for the additional risk that arises from the
…………………… location of the project.
6. …………………… 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.

7. If the blocked funds can be utilised in a foreign investment, the project cost to the investor
may be …………………… the local project construction cost.
8. Accounting for blocked funds in the capital budgeting process depends on the
…………………… cost of blocked funds.

13.2 Techniques of Capital Budgeting

The process of evaluating specific long-term investment decisions is known as the capital
budgeting or capital expenditure decision. This decision is one of the critical decisions faced by
the finance managers and is crucial to the success of a company. Companies devote significant
time and effort in planning capital budgeting decisions because a company that makes a mistake
in its capital budgeting process has to live with that mistake for a long time. Two popularly used
discounted cash flow techniques of capital budgeting are the Net Present Value (NPV) and
Internal Rate of Return (IRR).

Did u know? Both the techniques discount the project’s cash flow at an appropriate discount
rate. The results are then used to evaluate the projects based on the acceptance/rejection
criteria developed by management.

13.2.1 Net Present Value

The NPV method explicitly recognizes the time value of money. Companies use the NPV
method when they have to decide whether to continue with the existing equipment or buy new
equipment that would increase production efficiency. The NPV method is important because it
expresses in absolute terms the benefit of the project to the shareholders.
NPV is the most popular method and is defined as the present value of future cash flows
discounted at an appropriate rate minus the initial net cash outlay for the projects. The discount
rate used here is known as the cost of capital. The decision criteria is to accept projects with a
positive NPV and reject projects which have a negative NPV.
To implement the NPV method you need:
1. To calculate the present value of the expected cash inflows and outflows discounted at the
project’s cost-of-capital rate.
2. To subtract the present value of the cash inflows from the present value of the initial net
cash outflows to calculate the NPV of the project.

3. If the NPV of a project is positive, accept the project; if not reject the project.

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