Exam 18: Multinational Capital Budgeting and Cross-Border Acquisitions

The process of acquiring an enterprise anywhere in the world has three common elements EXCEPT:

Multinational firms should invest only if they can earn a risk-adjusted return greater than locally based competitors can earn on the same project.

Given a current spot rate of 8.10 Norwegian krone per U.S.dollar,expected inflation rates of 6% in Norway and 3% per annum in the U.S.,use the formula for relative purchasing power parity to estimate the one-year spot rate of krone per dollar.

When estimating a capital budget,it is common to separate cash flows into: 1)the initial investment,2)incremental cash flows over the life of the project,and 3)a terminal value.

Project financing is the arrangement of financing for very large individual long-term capital projects.

It is important that firms adopt a common standard for the capital budgeting process for choosing among foreign and domestic projects.

The level of debt places an enormous burden on cash flow for debt service and requires a number of additional levels of risk reduction.

Because international capital budgeting is so difficult,time consuming,expensive,and uncertain,firms generally forego any type of additional sensitivity analysis after completing a base-case scenario.

When a multinational firm invests abroad,it is common to develop two capital budgets: one from the project viewpoint,and one from the parent viewpoint.

Use the information to answer the following question(s). The Velo Rapid Revolutions Inc., a company that produces bicycles, elliptical trainers, scooters and other wheeled non-motorized recreational equipment is considering an expansion of their product line to Europe. The expansion would require a purchase of equipment with a price of euro 1,200,000 and additional installation of euro 300,000 (assume that the installation costs cannot be expensed, but rather, must be depreciated over the life of the asset). Because this would be a new product, they will not be replacing existing equipment. The new product line is expected to increase revenues by euro 600,000 per year over current levels for the next 5 years, however; expenses will also increase by euro 200,000 per year. (Note: Assume the after-tax operating cash flows in years 1-5 are equal, and that the terminal value of the project in year 5 may change total after-tax cash flows for that year.) The equipment is multipurpose and the firm anticipates that they will sell it at the end of the five years for euro 500,000. The firm's required rate of return is 12% and they are in the 40% tax bracket. Depreciation is straight-line to a value of euro 0 over the 5-year life of the equipment, and the initial investment (at year 0) also requires an increase in NWC of euro 100,000 (to be recovered at the sale of the equipment at the end of five years). The current spot rate is $0.95/euro , and the expected inflation rate in the U.S. is 4% per year and 3% per year in Europe. -Refer to Instruction 18.1.What is the IRR of the Velo Rapid Revolutions expansion?

Use the information to answer the following question(s). The Velo Rapid Revolutions Inc., a company that produces bicycles, elliptical trainers, scooters and other wheeled non-motorized recreational equipment is considering an expansion of their product line to Europe. The expansion would require a purchase of equipment with a price of euro 1,200,000 and additional installation of euro 300,000 (assume that the installation costs cannot be expensed, but rather, must be depreciated over the life of the asset). Because this would be a new product, they will not be replacing existing equipment. The new product line is expected to increase revenues by euro 600,000 per year over current levels for the next 5 years, however; expenses will also increase by euro 200,000 per year. (Note: Assume the after-tax operating cash flows in years 1-5 are equal, and that the terminal value of the project in year 5 may change total after-tax cash flows for that year.) The equipment is multipurpose and the firm anticipates that they will sell it at the end of the five years for euro 500,000. The firm's required rate of return is 12% and they are in the 40% tax bracket. Depreciation is straight-line to a value of euro 0 over the 5-year life of the equipment, and the initial investment (at year 0) also requires an increase in NWC of euro 100,000 (to be recovered at the sale of the equipment at the end of five years). The current spot rate is $0.95/euro , and the expected inflation rate in the U.S. is 4% per year and 3% per year in Europe. -Refer to Instruction 18.1.What are the annual after-tax cash flows for the Velo Rapid Revolutions project?

Which of the following is NOT an example of political risk?

Which of the following is NOT a factor critical to the success of project financing?

When determining a firm's weighted average cost of capital (wacc)which of the following terms is NOT necessary?

In project finance,retained earnings and the reinvestment of earnings are the most important decisions to guarantee the long term growth of the project's value.

The only proper way to estimate the NPV of a foreign project is to discount the appropriate cash flows first and then convert them to the domestic currency at the current spot rate.

Which of the following changes does NOT create business opportunities for select firms to both enhance and defend their competitive positions in global markets?

A foreign firm that is 20% to 49% owned by a parent is called a/an:

Explain how political risk and exchange rate risk increase the uncertainty of international projects for the purpose of capital budgeting.

The traditional financial analysis applied to foreign or domestic projects,to determine the project's value to the firm is called: