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Multinational Capital Budgeting Process
The original capital to be invested is identified.
Cashflows derived from the investment are estimated over time.
The cashflows are discounted using an appropriate discount rate to ascertain the present value of the cashflows.
A decision criteria such as net present value and/or internal rate of return is used to ascertain if the project will proceed.
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Foreign project evaluated from a parent viewpoint?
A strong theoretical argument exists in favor of analyzing any foreign project from the viewpoint of the parent.
Cash flows to the parent are ultimately the basis for dividends to stockholders, reinvestment elsewhere in the world, repayment of corporate-wide debt, and other purposes that affect the firm’s many interest groups.
However, since most of a project’s cash flows to its parent, or to sister subsidiaries, are financial cash flows rather than operating cash flows, the parent viewpoint usually violates a cardinal concept of capital budgeting, namely, that financial cash flows should not be mixed with operating cash flows.
Often the difference is not important because the two are almost identical, but in some instances a sharp divergence in these cash flows will exist.
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Foreign project evaluated from a project (local) viewpoint?
Evaluation of a project from the local viewpoint serves some useful purposes, but it should be subordinated to evaluation from the parent’s viewpoint.
In evaluating a foreign project’s performance relative to the potential of a competing project in the same host country, we must pay attention to the project’s local return.
Almost any project should at least be able to earn a cash return equal to the yield available on host government bonds with a maturity the same as the project’s economic life, if a free market exists for such bonds.
Host government bonds ordinarily reflect the local risk-free rate of return, including a premium equal to the expected rate of inflation.
If a project cannot earn more than such a bond yield, the parent firm should buy host government bonds rather than invest in a riskier project.
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Which viewpoint, project or parent, gives results closer to the traditional meaning of net present value in capital budgeting?
Both
Multinational firms should invest only if they can earn a risk-adjusted return greater than locally based competitors can earn on the same project.
If they are unable to earn superior returns on foreign projects, their stockholders would be better off buying shares in local firms, where possible, and letting those companies carry out the local projects.
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Internal rate of return (IRR) for a proposed foreign project
The key to distinction is “risk-adjusted.”
Foreign projects will be, by most methodologies, of higher risk than a domestic or home country project.
The anticipated returns should therefore take this into consideration.
Comparing expected returns with those earned by local companies in the target markets will not capture the cross-border risks (such as blocked funds) that a foreign investor may experience.
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Real Option Valuation
Option to defer
Option to abandon
Option to alter capacity
Option to start up or shut down (switching)
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Portfolio Risk Measurement
The risk of the individual security (SD of expected return)
The risk of the individual security as a component of a portfolio (beta).
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Project Finance
The arrangement of financing for long-term capital projects, large in scale, long in life, and generally high in risk.
Used widely in the development of large-scale infrastructure projects in China, India, and many other emerging markets.
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Equity in Project Financing
Equity is a small component
- The simple scale of the investment project often precludes a single investor or even a collection of private investors from being able to fund it.
- Many of these projects involve subjects traditionally funded by governments—such as electrical power generation, dam building, highway construction, energy exploration, production, and distribution.
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Project Finance Properties
Separability of the project from its investors
Long-lived and Capital-Intensive singular projects
Cash Flow predictability from third party commitments
Finite projects with finite lives
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Cross-border Mergers and Acquisitions (Reasons)
Gaining access to strategic proprietary assets
Gaining market power and dominance
Achieving synergies in local/global operations and across different industries
Becoming larger, and then reaping the benefits of size in competition and negotiation
Diversifying and spreading their risks wider
Exploiting financial opportunities they may possess and others desire
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Cross Border Acquisition (Process)
1 - Identification and Valuation of the target
- 2 - Execution of the acquisition offer
- and purchase—the tender
3 - Management of the post-acquisition transition.
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Cross Border Mergers and Acquisitions (Settlement)
Requires gaining the approval and cooperation of management, shareholders, and eventually regulatory authorities.
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International Capital Budgeting
Managers must evaluate political risk because political events can drastically reduce the value or availability of expected cash flows.
Parent cash flows must be distinguished from project cash flows. Each of these two types of flows contributes to a different view of value.
An array of nonfinancial payments can generate cash flows from subsidiaries to the parent, including payment of license fees and payments for imports from the parent.
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