Chapter 18
1. Capital Budgeting Theoretical Framework. Capital budgeting for a foreign project uses the same
theoretical framework as domestic capital budgeting. What are the basic steps in domestic capital
budgeting?
Multinational capital budgeting, like traditional domestic capital budgeting, focuses on the cash
inflows and outflows associated with prospective long-term investment projects. Multinational capital
2. Foreign Complexities. Capital budgeting for a foreign project is considerably more complex than the
domestic case. What are the factors that add complexity?
Capital budgeting for a foreign project is considerably more complex than the domestic case. Several
factors contribute to this greater complexity:
Parent cash flows must be distinguished from project cash flows. Each of these two types of
flows contributes to a different view of value.
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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.
Managers must anticipate differing rates of national inflation because of their potential to cause
changes in competitive position, and thus changes in cash flows over time.
Managers must keep the possibility of unanticipated foreign exchange rate changes in mind
because of possible direct effects on the value of local cash flows, as well as indirect effects on
the competitive position of the foreign subsidiary.
Use of segmented national capital markets may create an opportunity for financial gains or may
lead to additional financial costs.
Use of host-government subsidized loans complicates both capital structure and the parent’s
ability to determine an appropriate weighted average cost of capital for discounting purposes.
Managers must evaluate political risk because political events can drastically reduce the value or
availability of expected cash flows.
Terminal value is more difficult to estimate because potential purchasers from the host, parent, or
third countries, or from the private or public sector, may have widely divergent perspectives on
the value to them of acquiring the project.
3. Project versus Parent Valuation. Why should a foreign project be evaluated both from a project and
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,
4. Viewpoint and NPV. Which viewpoint, project or parent, gives results closer to the traditional
meaning of net present value in capital budgeting?
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letting those companies carry out the local projects. Apart from these theoretical arguments, surveys
during the past 35 years show that in practice multinational firms continue to evaluate foreign
investments from both the parent and project viewpoint.
5. Viewpoint and Consolidated Earnings. Which viewpoint gives results closer to the effect on
consolidated earnings per share?
6. Operating and Financing Cash Flows. Capital projects provide both operating cash flows and
financial cash flows. Why are operating cash flows preferred for domestic capital budgeting but
financial cash flows given major consideration in international projects?
7. Risk-Adjusted Return. Should the anticipated internal rate of return (IRR) for a proposed foreign
project be compared to (a) alternative home country proposals, (b) returns earned by local companies
in the same industry and/or risk class, or (c) both? Justify your answer.
8. Blocked Cash Flows. In the evaluation of a potential foreign investment, how should a multinational
firm evaluate cash flows in the host foreign country that are blocked from being repatriated to the
firm’s home country?
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flow-based financial analyses, the critical element is when the parent investor will regain the ability to
move the blocked funds freely.
9. Host Country Inflation. How should an MNE factor host country inflation into its evaluation of an
investment proposal?
10. Cost of Equity. A foreign subsidiary does not have an independent cost of capital. However, in order
to estimate the discount rate for a comparable host-country firm, the analyst should try to calculate a
hypothetical cost of capital. How is this done?
As part of this process, the analyst can estimate the subsidiary’s proxy cost of equity by using the
traditional equation: ke = krf +β (km – krf). Define each variable in this equation and explain how the
11. Viewpoint Cash Flows. What are the differences in the cash flows used in a project point of view
analysis and a parent point of view analysis?
12. Foreign Exchange Risk and Capital Budgeting. How is foreign exchange risk sensitivity factored
into the capital budgeting analysis of a foreign project?
In the chapter problem, the project team assumed that the Indonesian rupiah would depreciate versus
the U.S. dollar at the purchasing power parity “rate” (approximately 20.767% per year in the baseline
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13. Expropriation Risk. How is expropriation risk factored into the capital budgeting analysis of a
foreign project?
14. Real Option Analysis. What is real option analysis? How is it a better method of making investment
decisions than traditional capital budgeting analysis?
Real options is a different way of thinking about investment values. At its core, it is a cross between
decision-tree analysis and pure option-based valuation. It is particularly useful when analyzing
investment projects that will follow very different value paths at decision points in time where
15. M&A Business Drivers. What are the primary driving forces that motivate cross-border mergers and
acquisitions?
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value. The primary forces of change in the global competitive environment—technological change,
regulatory change, and capital market change—create new business opportunities for MNEs, which
they pursue aggressively.
As opposed to greenfield investment, a cross-border acquisition has a number of significant
advantages. First and foremost, it is quicker. Greenfield investment frequently requires extended
periods of physical construction and organizational development. By acquiring an existing firm, the
MNE shortens the time required to gain a presence and facilitate competitive entry into the market.
Second, acquisition may be a cost-effective way of gaining competitive advantages, such as
technology, brand names valued in the target market, and logistical and distribution advantages, while
simultaneously eliminating a local competitor. Third, specific to cross-border acquisitions,
international economic, political, and foreign exchange conditions may result in market
imperfections, allowing target firms to be undervalued.
16. Three Stages of Cross-Border Acquisitions. What are the three stages of a cross-border acquisition?
What are the core financial elements integral to each stage?
17. Currency Risks in Cross-Border Acquisitions. What are the currency risks that arise in the process
of making a cross-border acquisition?
18. Contingent Currency Exposure. What are the largest contingent currency exposures that arise in the
process of pursuing and executing a cross-border acquisition?