Capital Budgeting - Part 2

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Complexities of Budgeting for a Foreign Project • Cash Flows • Parent cash flows must be distinguished from project cash flows • Parent cash flows often depend on the form of financing • Cannibalization from other subsidiaries - Additional cash flows generated by a new investment in one foreign subsidiary may be in part or in whole taken away from another subsidiary, with the net result that the project is favorable from a single subsidiary's point of view but contributes nothing to worldwide cash flows • Remittance of funds - differing tax systems, legal and political constraints on the movement of funds, local business norms, and differences in the way financial markets and institutions function • Nonfinancial payments can generate cash flows from subsidiaries to the parent - payment of license fees and payments for imports from the parent
Complexities of Budgeting for a Foreign Project • Management Expectations • Unanticipated foreign exchange rate • Segmented national capital markets - opportunity for financial gains or may lead to additional financial costs • Host-government subsidized loans - complicates both capital structure and the parent's ability to determine an appropriate weighted average cost of capital for discounting purposes • Political risk • Terminal value is more difficult to estimate
Complexities of Budgeting for a Foreign Project • Project Versus Parent Valuation - A strong theoretical argument exists in favor of analyzing any foreign project from the viewpoint of the parent - Cash flows to the parent are ultimately the basis for dividends to stockholders, reinvestment elsewhere in the world, repayment of corporate-wide debt, and other purposes that affect the firm's many interest groups - However, this viewpoint violates a cardinal concept of capital budgeting, that financial cash flows should not be mixed with operating cash flows
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