January 9, 2021

Session 8:

International Capital Budgeting

Global Financial Management

Meng Gao

School of Business, University of Connecticut

Poll

•The adjusted present value (APV) model that is suitable for an

MNC is the basic net present value (NPV) model expanded to

•

A) distinguish between the market value of a levered firm

and the market value of an unlevered firm.

B) discern the blocking of certain cash flows by the host

country from being legally remitted to the parent.

C) consider foreign currency fluctuations or extra taxes

imposed by the host country on foreign exchange

remittances.

D) all of the options

Quiz

•Given the following information for a levered and unlevered firm, calculate

the difference in the cash flow available to investors. Assume the corporate

tax rate is 40 percent. (Hint: Calculate the tax savings arising from the tax

deductibility of interest payments).

•A) $8

B) $18

C) $78

D) $90

Levered Unlevered

Revenue $ 250 $ 250

Operating cost −$ 100

−$

100

Interest expense −$ 20 $ 0

Outline

•Review of domestic capital budgeting

•The adjusted present value model

•Capital budgeting from the parent firm’s perspective

•Risk adjustment in the capital budgeting analysis

•Sensitivity analysis

•Purchasing power parity assumption

•Real options

18-4

Copyright © 2021 by the McGraw-Hill Companies, Inc. All rights reserved.

•Consider a project with the following data

•The 5-year project requires equipment that costs $100,000. If

undertaken, the shareholders will contribute $20,000 cash and

borrow $80,000 at 6% with an interest-only loan with a maturity

of 5 years and annual interest payments. The equipment will be

depreciated straight-line to zero over the 5-year life of the

project. There will be a pre-tax salvage value of $5,000. There

are no other start-up costs at year 0. During years 1 through 5,

the firm will sell 25,000 units of product at $5; variable costs are

$3; there are no fixed costs. Debt-to-equity ration is 4.

•What is the NPV of the project using the WACC methodology?

•What is the present value of the project using the APV

methodology?

Q1: NPV vs APV

i=rdebt=6% requity=27.84%

τ=tax rate=34% rf=2%

•Initial outlay

–Equipment that costs $100,000

–Financing decision:

•$20,000 in equity; (re=27.84%)

•$80,000 in debt (6% interest, 5 year)

•CF years 1 through 5,

–sell 25,000 units at $5

–variable costs are $3; there are no fixed costs

–straight-line to zero depreciation over 5 years (over $100,000)

•Terminal value

–pre-tax salvage value of $5,000

•Tax rate: 34%

•NPV: What is WACC?

•APV: What is Ku?

•NPV: What are FCFs during year 1 through 5?

•APV: What are OCFs during year 1 through 5?

Q1: NPV vs APV (Cnt’d)

Capital Budgeting from the Parent Firm’s Perspective