Page 231 - DMGT549_INTERNATIONAL_FINANCIAL_MANAGEMENT

International Financial Management

Notes 13.4 Keywords

APV Model: APV model is a value additivity approach to capital budgeting, i.e., each cash flow
as a source of value is considered individually.

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.
Capital Budgeting: The process in which a business determines whether projects such as building
a new plant or investing in a long-term venture are worth pursuing.
DCF Techniques: DCF technique involves the use of the time-value of money principle to project
evaluation.

Foreign Exchange Risk: The risk that the currency will appreciate or depreciate over a period of
time.
IRR: IRR is defined as the discount rate that equates the present value of expected future cash
inflows with the present value of the project’s initial cash outflows.
NPV: 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.

Payback Period: Payback period in capital budgeting refers to the period of time required for
the return on an investment to “repay” the sum of the original investment.

13.5 Review Questions

1. Why should capital budgeting for subsidiary projects be assessed from the parent company’s
perspective? Give reasons.
2. What additional factors deserve consideration in multinational capital budgeting that are
not normally relevant for a purely domestic project?
3. Why is capital budgeting analysis important to a firm?
4. Enumerate the various problems and issues in foreign investment analysis.
5. Describe the various methods of capital budgeting that are normally adopted by MNCs.

6. What are blocked finds? Elucidate with examples.
7. Describe the four main avenues by which cash flow returns to a parent are derived.
8. ‘A foreign project normally is more beneficial to the parent when the foreign currency
appreciates over the life of the project.’ Elucidate with examples.
9. Examine the impact of exchange rate movements on cash flows to the parent/to the
subsidiary.

10. Zerox Inc. is a MNC with businesses all over the world. It is considering a Euro 20 million
expansion of their existing business line. The following details are provided: (i) The initial
expense will be depreciated straight-line over 5 years to zero salvage value; the pretax
salvage value in year 5 will be Euro 15,000. (ii) The project will generate pretax earnings
of Euro 3,20,000 per year, and keep the risk level constant. (iii) The firm can raise a 5-year
Euro 10,000,000 loan at 10.5% to partially finance. (iv) If the project were financed with all
equity, the cost of capital would be 15%. The corporate tax rate is 40%, and the risk-free
rate is 4%. (v) The project will require a Euro100,000 investment in net working capital.

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