Multinational

Capital Budgeting
General Approach

Identify initial capital

requirements
Estimate cash flows from
project
Determine appropriate
discount rate
Calculate NPV
 Complexities
Parent cash flows are different from project
cash flows
Traditional view of operational flows
challenged
Inflation differences
Tax differences
Capital structure differences
Cost of capital differences
 Complexities (con’t)

Foreign exchange fluctuations

Use of segmented capital markets
Terminal valuation difficulties
 Parent vs Project
Normal concept - do not mix operating
and financial cash flows
The parent generally involves financial
cash flows
But it is at the parent level we are
concerned! It shows impact on
consolidated returns
Build or Buy
Should only build if the
project has a risk-
adjusted return greater
than can be achieved by
local competitors
Otherwise, buy from the
local competitors
Purchasing Power Parity

Spot rate index n

(year ) =
1+fx inflation rate ( n
( 1+home inflation rate

Spot rate index (yearn) -1 = % change from t=0

 Steps in Multinational
Capital Budgeting

Determine current spot rates

Determine cost of
investment in both
currencies
Determine PPP index and
future spot rates
Steps in Multinational
Capital Budgeting
Determine parent supplied
financing in both currencies
Calculate debt amortization
schedule of foreign source
debt
Calculate debt amortization
of company supplied debt in
home currency
Steps in Multinational
Capital Budgeting

Calculate debt
amortization of company
supplied debt in foreign
currency as scheduled
(initial spot rate) (used to
determine foreign
exchange losses)
 Steps in Multinational
Capital Budgeting
Calculate debt
amortization of company
supplied debt in foreign
currency to be paid at
expected future spot rates
(used to determine foreign
WACC and foreign
exchange losses)
 Steps in Multinational
Capital Budgeting

Determine foreign exchange

losses (actual vs scheduled
debt service)
Determine WACC for parent
in home currency
Determine WACC for
subsidiary in foreign currency
Steps in Multinational
Capital Budgeting
Forecast subsidiary operations
in fx
Determine dividend payment
rate to parent
Calculate free cash flows and
terminal value of subsidiary to
determine IRR
Determine whether IRR can be
achieved by local competition
Continuing Value or
Terminal Value
CV = Free Cash FlowT+1
WACC – g
 Determining Free Cash Flow
Net income $1,807

Add: Income tax provision 1,194

Add: Interest expense 835

Earnings before interest & taxes (EBIT) 3,836

Less: CASH taxes (Provision adjusted for deferred taxes and tax effect of interest) 1,552

Net Operating Profit after Tax (NOPAT) 2,284

Add: Depreciation & amortization 1,762

Add (Subtract): Working Capital Decreases (Increases) (284)

Subtract: Capital expenditures (1,771)

Add (Subtract): Decreases (Increases) in Operating non-current assets (6)

Free Cash Flow $1,985

Steps in Multinational
Capital Budgeting
Determine foreign tax rates on
various funds flows to parent
Calculate the various net payments
received in parent currency
(including the terminal value)
Adjust parent WACC to reflect
subsidiary project risk
Discount parent cash flows (which
include a lot of financing) to
determine if the project has a
positive NPV
 Real Options 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.
Real option valuation also allows us to analyze a number of
managerial decisions that in practice characterize many major
capital investment projects:
The option to defer
The option to abandon
The option to alter capacity
The option to start up or shut down