Presented By Dated : 4th May 2018

1. Syeda Sehrish
2. Ahmad
3. Ahmed Faraz Syed
4. Arsalan Qureshi
5. Muhammad Kamran
6. Mueen Tariq

Presented To
Ma’am Hania

MBA 1.5 weekend NUML Multan Campus

 To compare the capital budgeting analysis of
an MNC’s subsidiary with that of its parent;
 To demonstrate how multinational capital
budgeting can be applied to determine
whether an international project should be
implemented; and
 How MNCs can be adapted to account for
special situation such as alternate exchange
rate;
 To explain how the risk of international projects
can be assessed.
Multinational capital budgeting, like
traditional capital budgeting, focuses on
cash inflows and outflows associated with
long-term investments.

MNCs determine whether an International

Project is feasible by comparing the Present
Value of that project’s Expected Future Cash
Flows to the Initial Investment.
 Should the capital budgeting for a multi-
national project be conducted from the
viewpoint of the subsidiary that will
administer the project, or the parent that will
provide most of the financing
 The results may vary with the perspective
taken because the net after-tax cash inflows
to the parent can differ substantially from
those to the subsidiary.
The difference in cash inflows is due to :
 Tax differentials
 What is the tax rate on remitted funds?
 If the parent’s government imposes a
high tax rate on the remitted funds, the
project may be feasible from the
subsidiary’s point of view, but NOT from
the parent’s point of view!

Parent should NOT consider!

 Regulations that restrict remittances

 Where host government restrictions require a

percentage of the subsidiary earnings to
remain in the host country and parent may
never have access to these funds, the
project is NOT attractive to the parent.

This may be considered though since the portion of

funds not allowed to be sent to the parent can be used
to cover the financing costs over time.
 Excessive remittances

 The parent may charge its subsidiary very high

administrative fees.
 Consider a parent that charges the
subsidiary very high administrative fees
because management is centralized at the
headquarters, the fees represent an
expense for the subsidiary and for the
parent, the fees represent revenue that may
substantially exceed the actual cost of
managing the subsidiary.
 Exchange rate movements

 When earnings are remitted to the parent,

they are normally converted from the
subsidiary’s local currency to the parent’s
currency. The amount received by the
parent is therefore influenced by the existing
exchange rate.
 A parent’s perspective is appropriate when
evaluating a project, since any project that
can create a positive net present value for
the parent should enhance the firm’s value.

 However, one exception to this rule occurs

when the foreign subsidiary is not wholly
owned by the parent.
 Cash Flows Generated by Subsidiary Corporate Taxes
Paid to Host
Government
After-Tax Cash Flows to Subsidiary
Retained Earnings
by Subsidiary
Cash Flows Remitted by Subsidiary
Withholding Tax
Paid to Host
After-Tax Cash Flows Remitted by Subsidiary Government

Conversion of Funds
to Parent’s Currency
Cash Flows to Parent

Parent
The following forecasts are usually required:
1 . Initial investment
2 . Consumer demand over time
3 . Product price over time
4 . Variable cost over time
5 . Fixed cost over time
6 . Project lifetime
7 . Salvage (liquidation) value
8 . Restrictions on fund transfers
9. Tax payments and credits
10. Exchange rates
11. Required rate of return
 This may constitute the major source of funds
to support a particular project. Funds initially
invested in a project may include not only
whatever is necessary to start the project but
also additional funds, such as working capital,
to support the project over time. Such funds
are needed to finance inventory, wages, and
other expenses until the project starts to
generate revenue. Because cash inflows will
not always be sufficient to cover upcoming
cash outflows, working capital is needed
throughout a project’s lifetime.
 An accurate forecast of consumer demand
for a product is quite valuable, but future
demand is often difficult to forecast.
Demand forecasts can sometimes be aided
by historical data on the market share other
MNCs in the industry pulled when they
entered this market, but historical data are
not always an accurate indicator of the
future.
 The price at which the product could be sold
can be forecasted using competitive
products in the markets as a comparison.
The future prices will most likely be responsive
to the future inflation rate of the host country,
but the future inflation rate is NOT known.
Thus, future inflation rates must be forecasted
in order to develop projections of the
product price over time.
 Like the price estimate, variable-cost
forecasts can be developed from assessing
prevailing comparative costs of the
components (i.e. hourly labor costs). Such
costs should normally move in tandem with
the future inflation rate of the host country.
Even if the VC/u can be accurately
predicted, the projected total variable cost
may be wrong if the demand is inaccurately
forecasted.
 Fixed cost is sensitive to any change in the
host country’s inflation rate from the time the
forecast is made until the time the FC are
incurred.
 Some projects have indefinite lifetimes that
can be difficult to assess, while other projects
have designated specific lifetimes, at the end
of which they will be liquidated. This makes
the capital budgeting analysis easier to
apply.
 An MNC does not always have complete
control over the lifetime decision. In some
cases, certain events (i.e. Political) may force
the firm to liquidate the project earlier than
planned.
 The after-tax salvage value of most projects is
difficult to forecast. It will depend on several
factors, including the success of the project
and the attitude of the host government
toward the project. As an extreme possibility,
the host government could take over the
project without adequately compensating the
MNC.
 In some cases, a host government will prevent a
subsidiary from sending its earnings to the
parent. This restriction may reflect an attempt
to encourage additional local spending or to
avoid excessive sales of the local currency in
exchange for some other currency.
 The tax laws on earnings generated by a
foreign subsidiary or remitted to the MNC’s
parent vary among countries. Because after-
tax cash flows are necessary for an adequate
capital budgeting analysis, international tax
effects must be determined on any proposed
foreign projects.
 Any international project will be affected by
exchange rate fluctuations during the life of the
project, but these movements are often very
difficult to forecast.
 Though hedging techniques can be used to
cover short and long-term positions (through
forward contracts and swaps), the MNC has no
way of knowing the amount of funds that it
should hedge.
 Once the relevant cash flows of a proposed
project are estimated, they can be
discounted at the project’s required rate of
return, which may differ from the MNC’s cost
of capital because of the at particular
project’s risk.
 Capital budgeting is necessary for all long-
term projects that deserve consideration.
 One common method of performing the
analysis involves estimating the cash flows
and salvage value to be received by the
parent, and then computing the net present
value (NPV) of the project. NPV is the net
present value of a firm or a project. It is to
evaluating the future expected cash flow
using discounted cash flow method.
NPV is the Net Present Value of a firm or a
project. It is to evaluating the future expected
cash flow using discounted cash flow
method.
 NPV = – initial outlay
n
+ S cash flow in period t
t =1 (1 + k )t
salvage value
+
(1 + k )n
k = the required rate of return on the project
n = project lifetime in terms of periods
 If NPV > 0, the project can be accepted.
Example:
 Spartan, Inc. is considering the development
of a subsidiary in Singapore that will
manufacture and sell tennis rackets locally.
 Period t
1. Demand (1)
2. Price per unit (2)
3. Total revenue (1)(2)=(3)
4. Variable cost per unit (4)
5. Total variable cost (1)(4)=(5)
6. Annual lease expense (6)
7. Other fixed annual expenses (7)
8. Noncash expense (depreciation) (8)
9. Total expenses (5)+(6)+(7)+(8)=(9)
10. Before-tax earnings of subsidiary (3)–(9)=(10)
11. Host government tax tax rate(10)=(11)
12. After-tax earnings of subsidiary (10)–(11)=(12)
 Period t
13. Net cash flow to subsidiary (12)+(8)=(13)
14. Remittance to parent (14)
15. Tax on remitted funds tax rate(14)=(15)
16. Remittance after withheld tax (14)–(15)=(16)
17. Salvage value (17)
18. Exchange rate (18)
19. Cash flow to parent (16)(18)+(17)(18)=(19)
20. PV of net cash flow to parent (1+k) - t(19)=(20)
21. Initial investment by parent (21)
22. Cumulative NPV SPVs–(21)=(22)
 Exchange rate fluctuations
Since it is difficult to accurately forecast
exchange rates, different scenarios can be
considered together with their probability of
occurrence.
 Inflation
Although price/cost forecasting implicitly
considers inflation, inflation can be quite
volatile from year to year for some countries.
 Financing arrangement
Financing costs are usually captured by the
discount rate.
However, when foreign projects are partially
financed by foreign subsidiaries, a more
accurate approach is to separate the
subsidiary investment and explicitly consider
foreign loan payments as cash outflows.
 Blocked funds
Some countries require that the earnings
generated by the subsidiary be reinvested
locally for at least a certain period of time
before they can be remitted to the parent.
Assume that all funds are blocked until the subsidiary is sold.
 Uncertain salvage value
Since the salvage value typically has a
significant impact on the project’s NPV, the
MNC may want to compute the break-even
salvage value.
 Impact of Project on Prevailing Cash Flows
The new investment may compete with the
existing business for the same customers.
 Host Government Incentives
Foreign projects proposed by MNCs
may have a favorable encouraged by
the host country and are therefore
encouraged by the host government.
Any incentives offered by the host
government must be incorporated into
the capital budgeting analysis.
 Real Options
The real option is an option on specified real
assets such as machinery or a facility. Some
capital budgeting projects contains real
options in that they may allow opportunities
to obtain or eliminate real assets. Since these
opportunities can generate cash flows , they
can enhance the value of a project
 When an MNC is unsure of the estimated
cash flows of a proposed project, it needs to
incorporate an adjustment for this risk.

Three Methods are commonly used to adjust

the evaluation for risk:
 One method is to use a risk-adjusted
discount rate. The greater the uncertainty,
the larger the discount rate that should be
applied to the cash flows.
 Once the MNC has estimated the NPV of a
proposed project, it may want to consider
estimates for its input variables.

 Simulation can be used for a variety of tasks,

including the generation of a probability
distribution for NPV based on a range of
possible values for one or more input
variables. Simulation is typically performed
with the aid of a computer.