Lecture 7 INTERNATIONAL CAPITAL BUDGETING課件

1、Week 28Dr. Shammyla Naeem Required Reading:oChapter 14 and Chapter 17 Supplementary Reading oAdrian Buckley, Peter J.S. Buckley, Pascal Langevin & Ka Lun Tse“The financial analysis of foreign investment decisions by large UK-based companies” The European Journal of Finance 2, 181-206 (1996)oTax

2、DifferentialsoRestricted RemittancesoExcessive RemittancesoExchange rate movementsConversion of Funds to Parents CurrencyCash Flows to ParentCorporate Taxes Paid to Host GovernmentRetained Earningsby SubsidiaryWithholding Tax Paid to Host GovernmentCash Flows Remitted by SubsidiaryAfter-Tax Cash Flo

3、ws to SubsidiaryCash Flows Generated by Subsidiary Initial Investment Consumer demand Price Variable Cost Fixed Cost Project Life Salvage Value Restrictions on find transfer Tax laws Exchange rates Required rate of return Cost of equity capital CAPM: re = rf +i(rm-rf) WACC: Using parent debt ratio (

4、future debt structure) Weights at MV, not BV. But WACC only appropriate if new project:oSame riskoSame capital structureoFinance elements same cost as company overall Unlikely to be the case in international investment Beta Are world markets segmented or integrated? Use either home- or world- market

5、 portfolio. E.g., w/Global CAPM: Focus on non-diversifiable risk Economic and political risk largely diversifiable High project risk may be offset by diversification benefit if low correlation between foreign market and home (or global) market index. Beta of foreign project may be lower than risk of

6、 domestic project. Ideally use local company as proxy Alternatively, estimate risk of proxy industry in local market. Third (least preferred) alternative home industry beta adjusted for foreign country beta. E.g., US firm e 1.2, rf 4% and expected risk premium 5%. Considering investment in Switzerla

7、nd. re? If US against world portfolio 1 and Swz 0.83. re US: 4%+1.2*5% 10% re Swz: 4%+1.2*0.83*5% 9% Equity risk premium (rp). rp = rm - rfDimson et al. (2002) in Buckley (2004): Historical percentage equity risk premium, 1900 2000.AgainstLTbondsAgainstSTbillsGeoArithGeoArithUK6.5US5.07.05.

8、87.7World6.2 Geometric or arithmetic average?o Geometric possibly more appropriate for describing LT realised returns, and more consistent with IRRo But is historic risk premium suitable predictor for future risk premium? Risk premium non-stable, Survivorship bias, based on index of success

9、ful firms, etc. Forecast Rp: 3-5%? (Was that too low?) Interest rate (rf). CAPM theoretically single-period (ST?) model, but LT interest rate may be more appropriate when estimating cost of capital for LT investment. cost of local currency loan = interest cost + exchange rate change. If parity theor

10、ies hold, expected exchange rate change match interest differential home country cost of local (foreign) debt cost of home debt? (But, tax differences and subsidies may cause net costs to differ).Cost of capital for international investment Estimating cost of capital for international investment com

11、plicated and controversial. Applying same cost of capital for international project as for domestic project probably conservative may understate diversification benefit.Cash Flows Focus on incremental CFs CF due to project Base case: Incremental CF = Global CF with project Global CF without project.

12、Cannibalisation New product/operation taking sales away from firms existing products? Sales that would have been lost anyway (e.g., competition) should not be counted as cannibalisation. Sales creation Increased sales of existing products if project accepted?Opportunity costs Alternative use of reso

13、urces?Transfer pricing May distort project profitability. For investment appraisal purposes, use transfer pricing at market prices. Fees and Royalties Transfers from sub to parent do not affect MNCs overall CFs? Starbucks? Only incremental fixed costs and overheads relevant Global CF without project

14、 seldom status quo. Existing products cannibalised by others if not by you? Does project open up future investment opportunities growth options? Parent vs Project cash flows Value of project = NPV of CFs available to investors Parent rather than subsidiary incremental CFs determine project value.Thr

15、ee-stageapproachtoevaluation: Incremental project CF from subsidiarys perspective Forecast amount, timing and form of transfers from subsidiary to parent, after tax. Account for indirect benefits and costs (cannibalisation and sales creation, etc).InvestmentappraisalandpoliticalriskAdjust discount r

16、ate? Shorten payback period? Both methods crude, and not recommended.Adjust CFs Base analysis on expected (mean) CFs. Recommended However, can company cope with potential losses?ExpropriationExample:Investment 1m. Project life 5 years, annual end-of-year CFs 500,000. r=20%. Possible nationalisation

17、at end of year 2, with 200,000 compensation.NPV no expropriation: -1m + 0.5m*2.991 = 495,500NPV w/expropriation:-1m + 0.5m*1.528 + 0.2m*0.694 = -97,200 Break-even probability of expropriation:0 = NPVexp*p + NPVno-exp*(1-p)0 = -97,200p + 495,500(1-p)592,700p = 495,500p = 0.836If probability of exprop

18、riation less than 83.6%, project NPV +ve.Expropriation of assets through courts Chevron Ecuador in ArgentinaSmokers and others through litigation (Beinish et al., 2010)ExchangerateeffectsRecommended approach usually:Forecast CFs in local currency and nominal terms, adjusting each CF for expected inf

19、lation.Convert to home currency using forecast exchange ratesCalculate present value using home currency nominal discount rates.Common problem to use real CFs and nominal discount rate.Internationalcapitalbudgetinginpractice Baker (1988): Wide variation, although most companies used company wide WAC

20、C unless foreign project had access to “cheap” funds, e.g., development bank funds, subsidised loans or grants. Buckley review of literature:oMost surveys find leading MNCs to be remarkable unsophisticated in analysis.oStudies suggest 50-80% use discounted cash flow models. Recent results no higher t