International capital Budgeting

1. PRESENTED BY
DHANYA K P
CUANCOM008
M.COM 4TH SEM
SEMINAR PRESENTATION
INTERNATIONAL CAPITAL BUDGETING: CONCEPT,
PROBLEMS ASSOCIATED, EVALUATION OF A
PROJECT, FACTORS AFFECTING, RISK
EVALUATION, IMPACT ON VALUE AND LONG TERM
ASSET LIABILITY MANAGEMENT.

2. INTERNATIONAL CAPITAL BUDGETING
• The evaluation of the long-term investment
project is known as capital budgeting
• The technique of capital budgeting is almost
similar between a domestic company and
international company. The only difference is that
some additional complexities appear in the case of
international capital budgeting.
• These complexities influence the computation of
the cash flow and the rate of return.

3. EVALUATION CRITERIA
• Discounting and Non discounting criteria
• Non discounting methods:
 Average accounting rate of return
Pay back period

4. AVERAGE ACCOUNTING RATE OF
RETURN
• It represents the mean profit on account of
investment prior to interest and tax
payment. The mean profit is compared with
the hurdle rate or required rate of return
earned by the project. A project is
acceptable if the mean profit is higher than
the hurdle rate,

5. PAY-BACK PERIOD
• The other non discounting method is
known as the pay-back period, that is the
number of years required to recover the
initial investment. If the investment is not
recovered within the pay-back period, the
project should not be accepted.

6. • Discounting methods:
 Net Present Value (NPV) method
 Profitability Index (PI) method
 Internal rate of return(IRR) Method

7. 1. NET PRESENT VALUE
• NPV is the residue after deducting the initial
investment from the PV of future cash flows
relating to a project. Positive NPV means
additions to the corporate wealth. In this case,
projects are accepted where the present value of
net cash inflow during the life span of the project
is greater than the initial investment.

8. 2. PROFITABILITY INDEX
• Profitability index is the ratio between the
present value of future cash flows and the initial
investment. This shows the relationship between
net cash flows and initial investment.

9. 3. INTERNAL RATE OF RETURN
Internal rate of return is the discount rate equating
the present value of future cash flows and the
initial investment. For accepting a project, IRR>
hurdle rate.
The project shall be acceptable if IRR is greater
than the required rate of rate of return.

10. PROFITABILITY INDEX VERSUS NET PRESENT
VALUE
• The same amount of cash inflow may yield
different results under the two methods. It is
possible that PI may be higher in case of
lower NPV and so the decision would be
different in case of these two different
methods.
• NPV represents an absolute value, it should
be relied upon even if the PI is higher.

11. RANKING OF PROPOSALS
• If there are two or more mutually exclusive
proposals, they need to be ranked in order of
preference.
• Under the NPV rule, first preference is given to a
proposal with the highest NPV but judged by the
IRR method and initial outlay differs, the decision
could be erroneous. In such cases, the incremental
approach is considered.

12. RISK ADJUSTMENT IN THE CAPITAL BUDJETING
ANALYSIS
1. Risk adjusted discount method:
This approach requires adjusting the discount rate upward or
downward for increases or decreases, respectively, in the systematic
risk of the project relative to the firm as a whole.
2. Certainty equivalent method:
This approach extracts the risk premium from the expected cash flow
to convert them in to equivalent riskless cash flows, which are then
discounted at the risk free rate of interest. This is accomplished by
multiplying the risky cash flow by a certainty equivalent factor that is
unity or less. The more risky the cash flow, the smaller is the
certainty-equivalent factor.

13. COMPUTATION OF THE CASH FLOW
• The taking up of a new project demands a part of a
firms current wealth, but in return, brings in funds
and adds to the firms stock wealth in future.
• Cash outflow occurs on account of capital
expenditure, other expenses (excluding
depreciation), and the payment of taxes.

14. • Cash inflow includes revenue on account of
additional sale or cash from eventually selling
of an asset which is known as salvage value.
• Cash flows are grouped under three heads:
1. initial investment during the period,t0.
2. Operating cash flow during the period t1 to
tn.
3. Terminal cash flow or the salvage value that
emerges at the end of the period, tn.

15. PARENT UNITS PERSPECTIVE AND THE
CASH FLOW
• The value of the project is determined by the Net
Present Value of the future cash flow available to
the investor. Since the parent company that is taken
in to account in context of international capital
budgeting.
• The cash flow is broadly compartmentalized into
three heads:
1. initial investment
2. operating cash flow
3. terminal cash flow

16. 1. INITIAL INVESTMENT
• If the entire project cost is met by the parent
company, the entire amount of initial investment
is treated as the cash out flow. In some cases,
the project is partly financed by the subsidiary
itself through local borrowing but such
borrowings of the subsidiary itself through local
borrowings of the subsidiary do not from a part
of the initial cash outflow.

17. 2. OPERATING CASH FLOW
• Besides the initial investment, the operating cash
flow too needs some adjustment. As a normal
practice, the revenue generated through the sale of
a subsidiary’s product in the local market as well
as in other countries, is known as the operating
cash flow from the parents perspective but it is
subject to downward adjustment by the lost
income on sales previously realized through the
parent company’s export of these markets.

18. 3. TERMINAL CASH FLOW
• Besides adjustments in the initial
investment and in the operating cash flow,
some adjustments have to be made for the
salvage value that influences the terminal
cash flow. If there is provision in the
foreign collaboration agreement for
reversion of the project to the government
after a certain period of time on the
payment of a specific amount, that specific
amount is treated as the terminal cash flow.

19. FACTORS AFFECTING INTERNATIONAL CAPITAL
BUDGETING
• Project Risk
Project risk approximates the chance that the project will
not be as profitable as expected due to errors from the
company or from the project's initial evaluation. Project
risk is increased when a company invests in a business
that is not in its area of expertise. This increases the
chance that management will not be able to properly
value the project's cash flows and that the company will
make errors while running the business.

20. • Market Risk
Market risk measures the part of a project's risk from
macroeconomic factors such as inflation and interest
rates. Market risk is increased during a weak economy. A
poor economy can decrease demand for a product,
potentially turning a project unprofitable. Banks may be
more reluctant to lend in a weak economy, raising the cost
of capital for the project. High inflation can also be a
problem at it weakens the long-term real return of the
project. These factors increase the market risk of a project
and contribute higher total risk.

21. • International Risk
If a company's capital budget project will involve another
country, it will be exposed to international risk. This entails
political and exchange-rate risk of the project. If a project
is based in a country with an unstable political structure,
civil or political unrest could cause the entire investment
to be lost. If currency rates move in an unfavorable
direction, the company could face higher relative costs
and lower relative gains. Domestic projects are completely
devoid of this type of risk.

22. ASSET LIABILITY MANAGEMENT
• Asset Liability Management (ALM) can be defined as a
mechanism to address the risk faced by a bank due to a
mismatch between assets and liabilities either due to
liquidity or changes in interest rates. Liquidity is an
institution’s ability to meet its liabilities either by
borrowing or converting assets. Apart from liquidity, a
bank may also have a mismatch due to changes in interest
rates as banks typically tend to borrow short term (fixed or
floating) and lend long term (fixed or floating).

23. • ALM involves Planning, directing and
Controlling the flow , mix, cost and yield of the
consolidated funds of bank
• Assesses various asset mixes, funding
combinations, price volume relations and their
implications on Liquidity, Income and Capital
ratio
• Planning procedure which accounts for all
assets and liabilities of a bank by rate, amount
and maturity

24. OVERALL OBJECTIVE..
• The central theme of (ALM) is the
management of a bank’s entire balance sheet
on continuous basis with a view to ensure a
proper balance between funds mobilisation and
their deployment with respect to their maturity
profiles, cost and yield as well as risk exposure
so as to improve profitability, ensure adequate
liquidity, manage risks and ensure long term
viability

25. • The immediate focus of ALM is interest-rate risk and
return as measured by a bank’s net interest margin.
• ALM is a systematic approach that attempts to provide
a degree of protection to the risk arising out of
asset/liability mismatch.
• NIM (Net Interest Margin) = (Interest income – Interest
expense) / Earning assets A bank’s NIM, in turn, is a
function of the interest-rate sensitivity, volume, and mix
of its earning assets and liabilities. That is, NIM = f
(Rate, Volume, Mix)

26. SCOPE OF THE ALM
• The exact roles and perimeter around ALM can vary significantly
from one bank (or other financial institutions) to another
depending on the business model adopted and can encompass
a broad area of risks.
• The traditional ALM programs focus on interest rate
risk and liquidity risk because they represent the most
prominent risks affecting the organization balance-sheet (as
they require coordination between assets and liabilities).
• But ALM also now seeks to broaden assignments such
as foreign exchange risk and capital management.

27. THE SCOPE OF THE ALM FUNCTION TO A LARGER
EXTENT COVERS THE FOLLOWING PROCESSES
• Liquidity risk: the current and prospective risk arising when
the bank is unable to meet its obligations as they come due
without adversely affecting the bank's financial conditions.
From an ALM perspective, the focus is on the funding
liquidity risk of the bank, meaning its ability to meet its
current and future cash-flow obligations and collateral needs,
both expected and unexpected. This mission thus includes
the bank liquidity's benchmark price in the market.
• Interest rate risk: The risk of losses resulting from
movements in interest rates and their impact on future cash-
flows.

28. • Currency risk management: The risk of losses resulting
from movements in exchanges rates. To the extent that
cash-flow assets and liabilities are denominated in
different currencies.
• Funding and capital management: As all the
mechanism to ensure the maintenance of adequate
capital on a continuous basis. It is a dynamic and
ongoing process considering both short- and
longer-term capital needs and is coordinated with
a bank's overall strategy and planning cycles
(usually a prospective time-horizon of 2 years).

29. • Profit planning and growth.
• ALM deals with aspects related to credit risk as this
function is also to manage the impact of the entire credit
portfolio (including cash, investments, and loans) on the
balance sheet. The credit risk, specifically in the loan
portfolio, is handled by a separate risk management
function and represents one of the main data contributors
to the ALM team.

30. CONCLUSION
• The technique of capital budgeting is almost similar
between a domestic company and an international
company. The only difference is that some additional
complexities appear in the case of international capital
budgeting. These complexities influence the computation of
the cash flow and the required rate of return.
• Risk management is the heart of bank financial
management and ALM is one of the most important risk-
management functions in a bank.

31. REFERENCES
• V. SHARAN, International Financial Management,
Prentice-Hall of India pvt ltd, New Delhi.
• M Y KHAN, FINANCIAL SERVICES, Tata M C Graw Hill, New
Delhi, 2004.

32. THANK YOU