Multinational Capital Budgeting

Chapter 14 - Multinational Capital Budgeting

Q: How to evaluate project?

A: NPV. The evaluation of MN project is similar to the evaluation of a domestic one.

Data Needed for Multinational Capital Budgeting:

1. CFs (Revenues[P & Q] and Costs[VC & FC])

2. Maturity (T)

3. Salvage Value (SVT)

4. Depreciation

5. Taxes (local and foreign, withholding, tax credits, etc.)

6. Exchange Rates (St)

7. Required Rate of Return (k)

8. Restrictions to Capital Outflows

Agency Problem: Subsidiary vs. Parent.

The subsidiary will want to undertake more projects, whereas the Parent only cares about Profitability. Subsidiary can misstate Revenues, VC, and Salvage Value.

Example: Project in Hong Kong (Data provided in HKD)

• T= 4 years

• CF0= HKD 70M

Price for Product = HKD 20 Year 1 Quantity = 1.00M

25 Year 2 0.95M

30 Year 3 0.90M

35 Year 4 0.85M

• VC = HKD 5/unit

• FC = HKD 3M

• Depreciation = 10% of initial outlay (HKD 7M/year)

• Taxes: HKD 17%, US 35% (Gross-up, Credit for foreign taxes)

Withholding tax=10%

• St = 7 HKD/USD (use RW to forecast future St’s)

• SV4 = HKD 25M

• k = 15%

1. Subsidiary’s NPV (in HKD including local taxes)

T=1 2 3 4

Revenues 20M 23.75M 27M 29.75M

Cost 5M 4.75M 4.5M 4.25M

3M 3M 3M 3M

Profit 12M 16M 19.5M 22.5M

Dep. 7M 7M 7M 7M

EBT 5M 9M 12.5M 15.5M

Taxes .85M 1.53M 2.125M 2.635M

EAT 4.15M 7.47M 10.375M 12.865M

Free CFs 11.15M 14.47M 17.375M 19.865M

Free CF +SV 11.15M 14.47M 17.375M 44.865M

NPV (in HKD) = -70M + 11.15M/1.15 + 14.47M/1.152 + 17.375M/1.153 + + 44.865M/1.154 = - HKD 12.2869M Subsidiary would accept the project. (This is likely to happen: the subsidiary will never submit a project to the parent company with a NPV No to the project.

A subsidiary will never submit a project like this (they want...