CHAPTER 18
MULTINATIONAL CAPITAL BUDGETING & CROSS–
BORDER ACQUISITIONS
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?
Capital budgeting for a foreign project uses the same theoretical framework as domestic
capital budgeting—with a few very important differences. The basic steps are:
1. Identify the initial capital invested or put at risk.
2. Estimate cash flows to be derived from the project over time, including an estimate of the
terminal or salvage value of the investment.
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:
▪ Additional cash flows generated by a new investment in one foreign subsidiary may be in
part or in whole taken away from another subsidiary, with the net result that the project is
favorable from a single subsidiary’s point of view but contributes nothing to worldwide
cash flows.
▪ The parent must explicitly recognize remittance of funds because of differing tax
systems, legal and political constraints on the movement of funds, local business norms,
and differences in the way financial markets and institutions function.
▪ 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.
3. Sensitivity Analysis. What is sensitivity analysis? How do MNEs use sensitivity analysis to
assess various types of risks inherent in investment decisions?
Sensitivity analysis is a technique used to study how to predict the outcome of an investment
decision under uncertainty. While it is important for most business forecasts, sensitivity
analysis is specifically important to MNEs since they operate under a great deal of
4. Viewpoint and NPV. Which viewpoint, project or parent, gives results closer to the
traditional meaning of net present value in capital budgeting?
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
5. Viewpoint and Consolidated Earnings. Which viewpoint gives results closer to the effect
on consolidated earnings per share?
The attention paid to project returns in various surveys probably reflects emphasis on
maximizing reported consolidated net earnings per share as a corporate financial goal. As
long as foreign earnings are not blocked, they can be consolidated with the earnings of both
the remaining subsidiaries and the parent. As mentioned previously, U.S. firms must
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?
If reinvestment opportunities in the country where funds are blocked are at least equal to the
parent firm’s required rate of return (after adjusting for anticipated exchange rate changes),
temporary blockage of transfer may have little practical effect on the capital budgeting
outcome, because future project cash flows will be increased by the returns on forced
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.
The key to distinction is “risk–adjusted.” Foreign projects will be, by most methodologies, be
8. MNEs’ Investment Decisions. When evaluating a potential foreign investment, how would
inflation in the host country affect an MNE’s decision to invest in that nation? Would
blocked cash flows also affect the MNE’s decisions?
Inflation influences the flows of cost and sales revenue streams. MNEs examine inflationary
trends in host countries to study whether they should invest in these nations, relocate, or
downsize. Sometimes inflationary pressures in the host country may not affect these
9. Host Country Inflation. How does host country inflation impact the operations of MNEs?
How can MNEs mitigate these effects?
Volatile prices in the host country discourage FDI since they cause uncertainty and make
long-term strategic management decisions quite difficult. From the standpoint of customers,
higher prices lead to lower real income, hence reducing sales. As for the MNE, costs would
rise, reducing its global competitiveness. In addition, inflation, or rather relative inflation in
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?
11. MNEs and International Capital Budgeting. What are some of the problems that MNEs
encounter during their capital budgeting process?
MNEs apply the same techniques of project evaluation when performing capital budgeting.
The issues that they must factor in include the interest rate of loans that they take, inflation
rates, economies of scale, and market size. However, they may face a number of additional
problems in the process. First, the tax rate in the host country must be studied and compared
12. Foreign Exchange, Expropriation, and Political Risks. What are the main differences
between foreign exchange, expropriation, and political risks?
As profitable as they may be, the main problem of investing in emerging markets is the high
vulnerability to various types of risks. Historically and prior to the abolition of the gold
standard, the most serious risks faced by MNEs were in developing countries with unstable
political systems. This was because of the fear of “expropriation risk,” or the likelihood that
new governments would nationalize or confiscate foreign-owned assets. But as nations
started to follow semi-pegged or floating exchange systems, foreign investors faced the risk
When investing in foreign nations, especially developing nations, MNEs may face
expropriation risk; i.e., the risk of a project or property taken over by the state. Sometimes,
there are risks of indirect expropriation where the government may interfere with the
13. Cross-Border Mergers and Acquisitions. Explain why cross-border mergers and
acquisitions are difficult to implement.
Cross-border mergers and acquisitions (M&As) have three common elements: identification
and valuation of the target; completion of the ownership change transaction; and the
management of the post-acquisition transition. During this process firms, face a number of
complex issues, making the implementation process quite tedious and difficult. Firms must
value the target enterprise on the basis of its projected performance in its market. They
14. Investment Analysis. Compare and contrast NPV, APV, and real option analysis, explaining
how each of these analysis techniques affects investment decisions.
Net present value (NPV) is a valuation method used to assess the value of projects. NPV is a
business valuation method used to determine the present value of an investment by the
discounted sum of all cash flows received from the project. Investment decisions for NPV are
to accept positive NPV projects and reject negative NPV projects. When performing option–
15. M&A Business Analysis. Should MNEs conduct real options or conventional financial
options analysis in cross-border M&As?
Conventional financial options are financial instruments that hedge against risks relating to a
specific underlying financial instrument. Real options provide businesses with rights or
options to undertake certain business initiatives, such as deferring, abandoning, expanding,
staging, or contracting a capital investment project. The main feature that distinguishes real
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?
The process of acquiring an enterprise anywhere in the world has three common elements: 1)
the tender, and 3) management of the post-acquisition transition.
17. Currency Risks in Cross-Border Acquisitions. What are the currency risks which arise in
the process of making a cross-border acquisition?
The pursuit and execution of a cross-border acquisition poses a number of challenging
foreign currency risks and exposures for an MNE. The nature of the currency exposure
related to any specific cross-border acquisition evolves as the bidding and negotiating
18. Contingent Currency Exposure. What are the largest contingent currency exposures which
arise in the process of pursuing and executing a cross-border acquisition?
The initial bid, if denominated in a foreign currency, creates a contingent foreign currency
exposure for the bidder. This contingent exposure grows in certainty of occurrence over time
as negotiations continue, regulatory requests and approvals are gained, and competitive