Tutorial 9 Answers
1. Why is capital budgeting analysis so important to the firm?
ANSWER: Capital investments involve large expenditures and the decisions are difficult
to reverse, and have long-term effects. Thus, capital budgeting decisions require careful
and thorough analysis.
2. What is the intuition behind the NPV capital budgeting framework?
ANSWER: The NPV methodology compares the present value of all cash inflows
of a project versus the present value of all project outflows. Positive NPV indicates that
inflows are enough to cover all operating costs and financing costs, hence the project
adds wealth to shareholders.
3. How would you incorporate political risk into the capital budgeting process of foreign
investment projects?
ANSWER:
The standard approach is to adjust the cost of capital upward to reflect political risk, and
discount the expected future cash flows at a higher rate. Alternatively, one can subtract
insurance premium for political risk from the expected future cash flows and use the
usual cost of capital, which is applied to domestic capital budgeting.
4. Why should capital budgeting for subsidiary projects be assessed from the parent’s
perspective? What additional factors that normally are not relevant for a purely domestic
project deserve consideration in multinational capital budgeting?
ANSWER: When a parent allocates funds for a project, it should view the project’s
feasibility from its own perspective. It is possible that a project could be feasible from a
subsidiary’s perspective but may not be feasible when considering a parent’s perspective
(due to foreign withholding taxes or exchange rate changes affecting funds remitted to
the parent).
Some of the more obvious factors are (1) exchange rates, (2) whether currency
restrictions may exist, (3) probability of a host government takeover, and (4) foreign
demand for the product.
5. a. Describe in general terms how future appreciation of the euro will likely affect the
value (from the parent’s perspective) of a project established in Germany today by a
U.S.-based MNC. Will the sensitivity of the project value be affected by the percentage
of earnings remitted to the parent each year?
b. Repeat this question, but assume the future depreciation of the euro.
ANSWER:
a. Future appreciation of the euro would benefit the parent since the euro earnings
would be worth more when remitted and converted to dollars. This is especially
true when a large percentage of earnings are sent to the parent.
b. The future depreciation of the euro would hurt the parent since the euro earnings
would be worth less when remitted and converted to dollars. This is especially true
when a large percentage of earnings are sent to the parent.
6. When considering the implementation of a project in one of various possible countries,
what types of tax characteristics should be assessed among the countries? (See the
chapter appendix)
ANSWER: Corporate taxes in the country should be considered by an MNC, along
with withholding taxes, and even individual tax rates imposed on the potential
employees. Excise taxes are also relevant.
