Page 230 - DMGT549_INTERNATIONAL_FINANCIAL_MANAGEMENT

Unit 13: Cross-border Capital Budgeting

Required Rate of Return: The company requires a 10 per cent return on this project. Notes
Advise the Indian Company regarding the financial viability of the proposal – should the
project be set up in France or not?

Additional Considerations
1. Blocked Funds: Assume that all funds are blocked until the end of the fifth year.
These funds can be reinvested locally to yield 6% annually after taxes. Show the
calculations and comment on the result.
2. Exchange Rate Fluctuations: Assume the following exchange rate scenario and
recalculate your results.
Alternative I
Year 1 Year 2 Year 3 Year 4 Year 5
6.80 6.90 6.95 7.00 7.05

Alternative II
Year 1 Year 2 Year 3 Year 4 Year 5
6.55 6.50 6.40 6.38 6.35
Question

How sensitive is the project to fluctuations in exchange rate? Comment.
Source: International Financial Management, Madhu Vij, Excel Books.

13.3 Summary

Capital Budgeting for the multinational firm presents several complexities which are not
there in domestic capital budgeting. Some of the important complexities are – parents
cash flows are different from project cash flows, MNCs are exposed to foreign exchange
risk, the two tax jurisdiction which the cash flows are subject to and the problems of
blocked funds.
When there are restrictions on the transfer of funds/cash flows to the parent then it
becomes difficult to calculate the viability of the project. Project cash flows consist of
profits and depreciation charges whereas parent’s each flows consist of the amounts that
can be legally transferred by the subsidiary.
The important issue here is – from whose perspective should the project be evaluated?
Both the subsidiary and parent’s perspective is appropriate here as each project, should
ultimately generate sufficient cash flows to the parent wealth and subsidiary.
Evaluating and analysing cash flows from both viewpoints reveals important aspects
about the project’s competitiveness and its contribution to the company as a whole.
The techniques employed in multinational capital budgeting include the NPV, IRR and
APV format.

The APV format is more suitable to the unique aspect of evaluating foreign project as it
allows, different components of the projects cash flow to be discounted separately.

The APV model is a value additivity approach to capital budgeting.

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