Exam 14: Multinational Capital Budgeting

Petrus Company has a unique opportunity to invest in a two-year project in Australia. The project is expected to generate 1,000,000 Australian dollars (A$) in the first year and 2,000,000 Australian dollars in the second. Petrus would have to invest $1,500,000 in the project. Petrus has determined that the cost of capital for similar projects is 14%. What is the net present value of this project if the spot rate of the Australian dollar for the two years is forecasted to be $.55 and $.60, respectively?

If a parent's perspective is used in analyzing a multinational project, the relevant cash flows are the dollars ultimately received by the parent as a result of the project; the relevant initial outlay is the investment by the parent.

The required rate of return used to discount the relevant cash flows from a foreign project may differ from the MNC's cost of capital because of that particular project's risk.

____ is not a method of incorporating an adjustment for risk into the capital budgeting analysis.

____ can cause the parent's after-tax cash flows to differ from the subsidiary's after-tax cash flows.

If a multinational project is assessed from the subsidiary's perspective, withholding taxes are ignored for project assessment.

The ____ is (are) likely the major source of funds to support a particular project.

In conducting a multinational capital budgeting analysis, the subsidiary's perspective should always be used.

Exhibit 14-1 Assume that Baps Corporation is considering the establishment of a subsidiary in Norway. The initial investment required by the parent is $5,000,000. If the project is undertaken, Baps would terminate the project after four years. Baps' cost of capital is 13%, and the project is of the same risk as Baps' existing projects. All cash flows generated from the project will be remitted to the parent at the end of each year. Listed below are the estimated cash flows the Norwegian subsidiary will generate over the project's lifetime in Norwegian kroner (NOK): The current exchange rate of the Norwegian kroner is $.135. Baps' exchange rate forecast for the Norwegian kroner over the project's lifetime is listed below: -Refer to Exhibit 14-1. Assume that NOK8,000,000 of the cash flow in year 4 represents the salvage value. Baps is not completely certain that the salvage value will be this amount and wishes to determine the break-even salvage value, which is $____.

According to the text, in order to develop a distribution of possible net present values from international projects, a firm should use:

If a subsidiary project is assessed from the subsidiary's perspective, then an expected appreciation in the foreign currency will affect the feasibility of the project ____.

If a U.S. parent is setting up a French subsidiary, and funds from the subsidiary will be periodically sent to the parent, the ideal situation from the parent's perspective is a ____ after the subsidiary is established.

If partial financing is provided by the foreign subsidiary, including foreign interest payments in the cash flow analysis may avoid overstatement of the estimated foreign cash flows.

Exchange rates for purposes of multinational capital budgeting:

Other things being equal, firms from a particular home country will engage in more international acquisitions if they expect foreign currencies to ____ against their home currency, and if their cost of capital is relatively ____.

Assume a U.S.-based MNC has a Chilean subsidiary that annually remits 30 million Chilean pesos to the U.S. If the peso ____, the dollar amount of remitted funds ____.

The objective of sensitivity analysis in capital budgeting is to determine how sensitive the NPV is to alternative values of the input variables.

An MNC is considering establishing a two-year project in New Zealand with a $30 million initial investment. The firm's cost of capital is 12%. The required rate of return on this project is 18%. The project is expected to generate cash flows of NZ$12 million in Year 1 and NZ$30 million in Year 2, excluding the salvage value. Assume no taxes, and a stable exchange rate of $.60 per NZ$ over the next two years. All cash flows are remitted to the parent. What is the break-even salvage value?

Because before-tax cash flows are necessary for an adequate capital budgeting analysis, international tax effects need not be determined on a proposed foreign project.

Blocked funds may penalize a project if the return on the forced reinvestment in the foreign country is less than the required rate of return on the project.