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INTERNATIONAL PROJECT
APPRAISAL
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RECENT GLOBAL TRENDS
FDI has been the major driving force towardsglobalization
Cross border M&A have also added to the CAUSE
Acquisitions bring major benefit
1)Existing customers
2)Foothold in destination market
4)Niche technologies to the company
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Developing countries like India Reluctant in FDI In recent years , India has moved to moved to more
liberal policies.
RBI has been liberalizing overseas investment norms .
Till eighties, most of FDIs was between developedcountries.
In recent years, entrepreneurs from developingcountries will move to lesser developed countries.
Indian corporate are spreading their wings rapidly.
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EXAMPLES OF LIBEREALIZED RBI NORMS:
Hiked the overseas direct Investment limit from 200%of the net worth to 300% of net worth.
Hiked the limit on overseas portfolio investments from
25% to 35% of their net worth.
Allowed Indian residents to remit up to US$100000per financial yr, previously it was US$50000.
From US$3 billion, RBI has allowed Mutual funds to
invest fund of US$4 billion in overseas market.
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SOME OF THE APPROACHES TO VALUE
A DOMESTIC INVESTMENT
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ADJUSTED PRESENT VALUE(APV)
FRAMEWORK
Its a two step process:
1) Evaluate the project as if it is financed entirely by
equity .The rate of discount is the required rate of
return on equity corresponding to the risk class of
the project.
2) Add the present values of any cash flows arising
out of special financing features the rate of discount
should reflect the risk associated with each of the
cash flows.
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PROJECT APPRAISAL INTHE INTERNATIONAL
CONTEXT
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MAIN HURDLES DIFFERENTIATING A
FOREIGN PROJECT
EXCHANGE RATE AND CAPITAL MARKET SEGMENTATION
POLITICAL OR COUNTRY RISK
INTERNATIONAL TAXATION
BLOCKED FUNDS
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EXCHANGE RATE RISK AND CAPITAL
MARKET SEGMENTATION
Since cash flows from a foreign project are
in foreign currency and therefore subject to
forex risk.
How to incorporate this in project valuation?Also what is the appropriate cost of capital
when the host and home country forex
markets are not integrated?
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POLITICAL OR COUNTRY RISK
Assets allocated abroad are subject to risk ofappropriation or nationalization by the host country govt
.Also there may be changes in withholding taxes,
remittances by the subsidiary to the parent.
Hence the main issue lies in incorporating these risks in
evaluating the project??
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INTERNATIONAL TAXATION
In most of the cases there might be the situation ofwithholding taxes on dividends and other income remitted
to the parent.
In addition, the home country government may tax this
income in the hands of the parent.
If double taxation avoidance treaty is there ,the parent may
obtain special credit for the taxes abroad.
There is also a related issue of transfer pricing which may
enable the parent to furthur reduce the overall tax burden.
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BLOCKED FUNDS
Sometimes , a foreign project can become an attractiveproposal because the parent has some funds
accumulated in a foreign country which cant be taken
out .
Investing these funds locally in a subsidiary or a JV may
then represent a better use of blocked funds.
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STEP BY STEP APPROACH TO THE
EVALUATION OF FOREIGN PROJECT
Treat the project as branch operation of parent company. All cash flows generated by the project- belongs to the parent
company.
Consider , project is fully equity financed, wholly owned
subsidiary of parent, formed under host country laws, having a
distinct legal identity.
Focus on various financial arrangements between parent and
subsidiary.
Consider all means- how to increase cash flow transfers between
parent and subsidiary and how to minimize tax burden
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REASONS FORCONSIDERING INTRA-
CORPORATE FINANCING
FROM EXTERNAL FINANCING
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THE THREE REASONS!!!
1)Intra corporate financing effects can be
estimated separately from external financing.
2) The nature of internal financing arrangements is
sensitive to the particular features of the tax laws in
the host and home country3)It forces the company to keep in mind that intra-
corporate financing impinges only on the allocation
of the profits between the parent and the subsidiary
and not a net gain or loss.
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EXAMPLE:
Titus ltd is considering a proposal to set up a fully owned manufacturing andsales subsidiary in Zimbabwe to serve the African and Middle-eastern
markets as well as to make a foray into the European market . Proposed
Quartz plant in Zimbabwe
Intial inv=Z$ 50,000,000
Balance of Z$ 50,000,000 in a local bank from its earlier export sales .this
can be repatriated to India after paying 48% tax.Comparable watches imported from europe and japan are currently sold at
Z$180 per watch.
The operating cost are estimated to be
Materials : Z$120.00 per watch
Labour : Z$25.00 per watch
Selling and other expenses : Z$ 5.00 per watch
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OPTIONS APPROACH TO PROJECT
APPRAISAL
Discounted cash flow approach NPV or APV haveserious drawbacks.
Both ignore the various operational flexibilities .
They assume that all operational decisions are made
once for all at the start of the project. In many situations, the project sponsors have the
freedom to alter some features of the project.
Done due to changes in govt. policies, competitive
pressures etc.
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SOME FLEXIBILITIES ARE:
1. Start of the project may be delayed till more info aboutthe variable like demand, cost, exchange rates are
obtained.
Example-
development of oil field may be delayed till oil priceshardens.
Starting of foreign plant may be postponed till the
foreign currency stabilizes.
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2. The project may be abandoned if the demand or priceforecast turn into be over optimistic operating costs
shoots up.
It may be temporarily closed down and re start when
the market conditions improved.
Example-
copper mine can be closed down when the copper
prices are low and restarted when market conditions
improved.
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3. The operational scale of the project may be expandedor contracted depending upon whether demand turns
out to be more or less than initially envisioned.
4. An input or output mix may be changed or different
technology may be employed.
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In recent years, the theory of option pricing has beenapplied to project appraisal to take account of these
operational flexibilities.
Example- an option to abandon a project can be viewed
as a put option. the option to sell the project assets-
with a strike price equal to the liquidation value of
project.
Option to start a project at later date is considered as
call option.
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In many cases , these choices can be incorporatedand evaluated using a decision tree approach.
In other cases, option pricing model like black-scholes
model can be used
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THE PRACTICE OF CROSS BORDER
DIRECT INVESTMENT APPRAISAL Some surveys were done regarding problems
of appraising investment projects in foreign
countries.
Many participants use DCF methods with
some version of asset pricing model to
estimate the cost of capital but make
adjustments for political and exchange risks.
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PAPER BY- KECK, LEVENGOOD AND
LONGFIELD (1998)
Large majority practitioners use DCF in method ofvaluation
In case of less integrated markets (Sri Lanka, Mexico
etc), exchange risks, political risks, sovereign risks and
unexpected inflation- considered important risk
factors in addition to market risks.
For integrated markets like the US, the UK- global
market portfolio (a risk factor) is used frequently.
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INTERNATIONAL JOINT VENTURES
Most common form of cross border investment is jointventures and other forms of alliances.
Between firm of host country and foreign country.
2 or more partners join hands as they have synergies
They might have strengths that complement eachother- in technology, distribution , market access etc.
A joint venture expects to have gain over and above
the sum of individual firms
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G
ame-theoretic model of bargaining the synergygain should be split equally.
Can also be done by proportional sharing of project
cash flows.
Example- 2 partners, A brings 30% investmentsB brings 70% investments ,
so the cash flows should be shared in the
same proportion.
Above situation can change with different tax regimesand tax rates.