Dividend Policy and Dividend Decision Theories.pptx
Multinational capital budgeting
1.
2. How does domestic capital budgeting differ from
multinational capital budgeting?
How do incremental cash flows differ from total project
cash flows?
What is the difference between foreign project cash flows
and parent cash flows?
How does APV analysis differ from NPV analysis?
How is the capital budgeting analysis adjusted for the
additional economic and political risks?
What is real option analysis?
3. Several factors make budgeting for a foreign project more
complex
Parent cash flows must be distinguished from project
Parent cash flows often depend on the form of financing,
thus cannot clearly separate cash flows from financing
Additional cash flows from new investment may in part or in
whole take away from another subsidiary; thus as stand
alone may provide cash flows but overall adds no value to
entire organization
Parent must recognize remittances from foreign investment
because of differing tax systems, legal and political
constraints
4. An array of non-financial payments can generate cash flows
to parent in form of licensing fees, royalty payments, etc.
Managers must anticipate differing rates of national inflation
which can affect differing cash flows
Use of segmented national capital markets may create
opportunity for financial gain or additional costs
Use of host government subsidies complicates capital
structure and parent’s ability to determine appropriate
WACC
Managers must evaluate political risk
Terminal value is more difficult to estimate because
potential purchasers have widely divergent views
5. NPV Analysis
If Projects are independent, those with a positive NPV will be accepted while those with a negative NPV will be rejected
It two projects are mutually exclusive, the project with the highest NPV greater than zero will be accepted.
The discount rate, k, is the expected rate of return on projects of similar risk as the riskiness of the firm as a whole.
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6. Consistent with the goal of maximizing shareholder
wealth.
Focuses on cash flows rather than accounting profits.
Emphasizes the opportunity cost of money invested.
Obeys the additivity principle.
7. Only the additional cash flows generated by the
project are relevant.
The difference between total and incremental cash
flows arises from:
Cannibalization
Sales creation
Opportunity cost
Transfer prices
Fees and royalties
8. The base case is represented by the worldwide
corporate cash flows without the investment.
In a competitive world, the base case needs to be
adjusted for competitive behavior.
New product
New production technology
Intangible benefits
9. Project risks and financial structures vary by country,
production state, and position in the life cycle of the
project.
Rather than modifying the WACC, cash flows can be
discounted at an all-equity rate, k*.
Reflects only the riskiness of the project’s expected
future cash flows.
Abstracts from the project’s financial structure.
Can be viewed as the company’s cost of capital if it were
all-equity financed, that is, with zero debt.
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The all-equity rate is based on the CAPM:
k* = rf + β* (rm – rf)
β* is the all-equity or unlevered beta
A levered equity beta, βe, is unlevered using the
following equation:
11. The value of a project is equal to the sum of the
following components:
PV of after-tax project cash flows but before financing
costs discounted at k*.
PV of tax savings on debt financing discounted at the
before-tax dollar cost of debt, id.
PV of any savings or penalties on interest costs
associated with project-specific financing discounted at
the before-tax dollar cost of debt, id.
13. Should cash flows be measured from the viewpoint of
the project or that of the parent?
Should the additional economic and political risks
that are uniquely foreign be reflected in cash flow or
discount rate adjustments?
14. Most firms evaluate foreign projects from both parent
and project viewpoints
The parent’s viewpoint analyses investment’s cash flows
as operating cash flows instead of financing due to
remittance of royalty or licensing fees and interest
payments
The parent’s viewpoint gives results closer to
traditional NPV capital budgeting analysis
Project valuation provides closer approximation of
effect on consolidated EPS
15. Project and parent cash flows can divergediverge significantly
due to:
Tax regulations
Exchange controls
Fees and royalties
Transfer pricing
Other factors
16. Stage1:
Project cash flows are computed from the subsidiary’s
perspective.
Stage 2:
Project cash flows to the parent are evaluated on the
basis of specific forecasts concerning the amount,
timing, and form of remittance.
Stage 3:
Account for the additional benefits and costs of the
project.
17. Estimating a project’s true profitability requires
various adjustments to the project cash flows:
Adjust for the effects of transfer pricing and fees and
royalties.
Adjust for global costs/benefits that are not reflected in
the project’s financial statements.
Cannibalization
Sales creation
Additional taxes
Diversification of production facilities and markets
18. Only after tax cash flows are relevant.
Actual taxes paid are a function of:
Time of remittance
Form of remittance
Foreign income tax rate
Withholding taxes
Tax treaties
Foreign tax credits
19. Computing the tax liabilities of foreign investments
assumes that:
The maximum amount of funds are available for
remittance each year.
The tax rate applied is the higher of the home or host
country rate.
20. Suppose that an affiliate will remit after-tax earnings of
$120,000 to its U.S. parent in the form of a dividend.
Assume the foreign tax rate is 20%, the withholding tax on
dividends is 4%, and excess foreign tax credits are
unavailable.
What is the additional tax owed to the U.S. government?
What is the marginal rate of additional taxation?
21. There are threethree main methods for incorporating the
additional political and economic risks into a foreign
investment analysis:
Shortening the payback period
Raising the required rate of return of the investment
Adjusting the cash flows to reflect the specific impact of
a given risk.
Uncertainty absorption
Adjusting the expected value of future cash flows
22. The analysis should also consider the appreciation or
depreciation of the US dollar.
Approach A:
Convert nominal foreign currency cash flows into nominal
home currency terms.
Discount those nominal cash flows at the nominal domestic
required rate of return.
Approach B:
Discount the nominal foreign currency cash flows at the
nominal foreign currency required rate of return.
Convert the resulting foreign currency present value into the
home currency using the current spot rate.
23. The preferred method is to adjust the cash flows of
the project to reflect the impact of a particular
political event on the present value of the project to
the parent.
The biggest risk is:
o Expropriation
o Blocked funds
24. Suppose a firm projects a $5 million perpetuity from an
investment of $20 million in Spain. If the required return
on this investment is 20%, how large does the probability
of expropriation in year 4 have to be before the investment
has a negative NPV? Assume that all cash flows occur at
the end of the year and that the expropriation, if it occurs,
will occur prior to the year 4 cash inflows or not at all.
There is no compensation in the event of expropriation.
25. DCF analysis cannot capture the value of the strategic
options, yet real option analysis allows this valuation.
Real option analysis includes the valuation of the
project with future choices such as:
The option to defer
The option to abandon
The option to alter capacity
The option to start up or shut down (switching)
26. Real option analysis treats cash flows in terms of
future value in a positive sense whereas DCF treats
future cash flows negatively (on a discounted basis).
The valuation of real options and the variables’
volatilities is similar to equity option math.
An expanded NPV rule consists of the traditional DCF
analysis plus the value of an option.