Principles: Principle 3: Cash Flows Are the Source of Value
10) Exchange rate risk:
A) exists when the contract is written in terms of the foreign currency.
B) exists also in direct foreign investments and foreign portfolio investments.
C) does not exist if the international trade contract is written in terms of the domestic currency.
D) all of the above.
Topic: 19.3 Capital Budgeting for Direct Foreign Investment
Keywords: exchange rate risk
Principles: Principle 3: Cash Flows Are the Source of Value
11) Risks of foreign direct investment potentially include:
A) exchange rate fluctuations.
B) political instability.
C) competition from foreign competitors.
D) all of the above.
Topic: 19.3 Capital Budgeting for Direct Foreign Investment
Keywords: exchange rate risk
Principles: Principle 3: Cash Flows Are the Source of Value
12) An important (additional) consideration for a direct foreign investment is:
A) political risk.
B) maximizing the firm’s profits.
C) attaining a high international P/E ratio.
D) all of the above.
Topic: 19.3 Capital Budgeting for Direct Foreign Investment
Keywords: political risk
Principles: Principle 3: Cash Flows Are the Source of Value
13) If the net present value of a direct foreign investment is negative, the multinational firm
should:
A) reject any proposals.
B) consider establishing a sales office.
C) consider licensing.
D) both A and C.
Topic: 19.3 Capital Budgeting for Direct Foreign Investment
Keywords: direct foreign investment
Principles: Principle 3: Cash Flows Are the Source of Value
27
14) Foreign countries claim that multinational corporations:
A) cause stability in their currencies in foreign exchange markets.
B) exploit local labor with low wages.
C) have no political or cultural loyalty.
D) both B and C.
Topic: 19.3 Capital Budgeting for Direct Foreign Investment
Keywords: direct foreign investment
Principles: Principle 3: Cash Flows Are the Source of Value
15) Capital markets in foreign countries:
A) offer lower returns than those obtainable in the domestic capital markets.
B) provide international diversification.
C) in general are becoming less integrated due to the widespread availability of interest rate and
currency swaps.
D) increase portfolio betas.
Topic: 19.3 Capital Budgeting for Direct Foreign Investment
Keywords: direct foreign investment
Principles: Principle 3: Cash Flows Are the Source of Value
16) Expropriation of plant and equipment without compensation is an example of financial risk
from direct foreign investments.
Topic: 19.3 Capital Budgeting for Direct Foreign Investment
Keywords: political risk
Principles: Principle 3: Cash Flows Are the Source of Value
17) Economic exposure refers to the overall impact of exchange rate changes on the value of the
firm.
Topic: 19.3 Capital Budgeting for Direct Foreign Investment
Keywords: direct foreign investment
Principles: Principle 3: Cash Flows Are the Source of Value
18) The cost of debt used in the international investment decision is the lesser of the parent’s or
the subsidiary’s cost of debt.
Topic: 19.3 Capital Budgeting for Direct Foreign Investment
Keywords: direct foreign investment
Principles: Principle 3: Cash Flows Are the Source of Value
28
19) Because a large part of a subsidiary’s equity funds comes from the parent, the subsidiary
should use the same cost of equity as the parent.
Topic: 19.3 Capital Budgeting for Direct Foreign Investment
Keywords: direct foreign investment
Principles: Principle 3: Cash Flows Are the Source of Value
20) Millheim Electronics is an American firm operating in India, whose government refuses to
allow Millheim to send its earnings out of the country. This is an example of repatriation of
profits.
Topic: 19.3 Capital Budgeting for Direct Foreign Investment
Keywords: direct foreign investment
Principles: Principle 3: Cash Flows Are the Source of Value
21) Multinational corporations can have lower cost of capital and more continuous access to
external finance compared to a domestic firm.
Topic: 19.3 Capital Budgeting for Direct Foreign Investment
Keywords: direct foreign investment
Principles: Principle 3: Cash Flows Are the Source of Value
22) The relevant sources of risk for direct foreign investment capital budgeting decisions are the
same as those faced when making domestic capital budgeting decisions.
Topic: 19.3 Capital Budgeting for Direct Foreign Investment
Keywords: direct foreign investment
Principles: Principle 3: Cash Flows Are the Source of Value
29
23) The interest rate in the U.S. is 4%, in Switzerland it is 3%. The spot rate is 1.0232 USD to
the Swiss franc. A U.S. based hotel chain needs to project forward exchange rates for the next
five years. Complete the table below.
Year Spot
Rate
x rate
differential Forward Rate
0
1
2
3
4
5
1
2
3
4
5
$0.9700/SF (1.00977)5$1.01832/SF
Topic: 19.3 Capital Budgeting for Direct Foreign Investment
Keywords: forward rates
Topic: 19.3 Capital Budgeting for Direct Foreign Investment
Keywords: forward rates
Principles: Principle 3: Cash Flows Are the Source of Value
30
25) What are some of the potential risks, other than exchange rate risk, that need to be considered
in foreign direct investment decisions.
Topic: 19.3 Capital Budgeting for Direct Foreign Investment
Keywords: political risk
Principles: Principle 3: Cash Flows Are the Source of Value
26) Briefly discuss the factors that multinational firms consider in arriving at capital structure
decisions.
Topic: 19.3 Capital Budgeting for Direct Foreign Investment
Keywords: direct foreign investment
Principles: Principle 3: Cash Flows Are the Source of Value
31