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Determinants of the cost

ofInternational Projects

&their Management

byRajat Jhingan

PGDM FT (08-10)

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Capital BudgetingCapital budgeting requires estimation of a projects

incremental cash flows - which are determined by

estimating worldwide cash flows with and without the

project.There are two main methods of international capital

budgeting, centralized and decentralized

Centralized requires exchange rate forecasts

Decentralized requires a local-currency cost of capital.

The method a firm selects should depend on its

comparative advantage in estimating each

By: Rajat Jhingan

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International Project : Objectives

Shareholders wealth is created when return in the

Present Value is more than Investment Cost

Firm that could source funds internationally rather

domestically will have lower cost of capital.

Greater Opportunities to raise funds

Positive NPVs

APV Model given by Donald Lessard (1985)

By: Rajat Jhingan

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Determinants of cost of International Projects

Cash flows

Marginal corporate tax rate

Operating cash flow

Incremental revenues & operating costRestricted funds

Concessionary loans

WACC

AdditionalTransfer Pricing Strategies, LicensingAgreements, Royalty Agreements

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ADJUSTED PRESENT VALUE Given by: Donald Lessard (1985)

ValueAdditivity approach to capital budgeting.

Each cash flow is discounted at a rate of discount consistent with the

risk inherent in the cash flow.

Useful for:

MNC for analyzing one of its domestic capital expenditure

Foreign subsidiary of the MNC, a proposed capital expenditure

from the subsidiarys viewpoint.

A project may have a positive APV from the subsidiarys

perspective and a negative APV from the parents perspective.

The model recognizes that the cash flows will be dominated in a

foreign currency and will have to be converted into the currency of

the parent. By: Rajat Jhingan

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Estimate Future Expected Exchange Rate

It is required to Estimate Future Expected Exchange Rate in order toimplement the APV framework.

PPP theory is helpful in Estimate Future Expected Exchange Rate.

St = So (1+ d)t

(1+ f) t

St= future expected exchange rate

T= no of years

d= expected long run annual rate of inflation in the homecountry

F= rate of foreign land

So= current exchange rate

By: Rajat Jhingan

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Political Risk Centralized capital budgeting requires expected cash

flows to be adjusted for political risk - not cost of

capital.

Foreign political risk is unlikely to be systematic to the

risks of domestic shareholder portfolios.

Sensitivity analysis is an alternative to calculation of

exact political risk probabilities: solve for probability

that sets NPV=0 and then ask whether its reasonable -

if so, NPV is quite possibly negative.

By: Rajat Jhingan

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Thank You!!!!

By: Rajat Jhingan