International Capital Budgeting
International Capital Budgeting
International Capital Budgeting
Budgeting (Ch18)
Learning Objectives
The Adjusted Present Value (APV) Model
Capital Budgeting from the Parent Firms Perspective
Risk Adjustment in the Capital Budgeting Process
Sensitivity Analysis
MM Proposition
Modigliani and Miller (1963): the market value of a levered
firm is greater than an equivalent unlevered firm earning
the same net operating income (NOI=R-OC-D):
VL=Vu+t*Debt
Because the levered firm has tax savings from the tax
deductibility of interest payments to bondholders that do not
go to the government.
TVT
(1 + ku)
C0
APV
The APV model is a value additivity approach to capital
budgeting:
Each cash flow that is a source of value to the firm is
discounted at a rate that reflects the riskiness of the cash
flow.
APV =
t=1
(Rt- OCt)(1 ) D
It
TVT
t
+
+
+
C0
t
t
t
T
(1 + ku)
(1 + i) (1 + i)
(1 + ku)
APV Example
The timing and size of the after-tax operating cash flows for
an all-equity firm are:
-$1,000
0
$125
1
CF0
= $1000
CF1
= $125
CF2
= $250
CF3
= $375
CF4
= $500
$250
2
$375
3
$500
= 10
= $56.50
APV =
$125
1.10
$19.20
1.08
$250
(1.10)
$19.20
(1.08)
$375
(1.10)
$19.20
(1.08)
$500
(1.10)4
$19.20
(1.08)4
$1,000
T
T
St (Rt OCt )(1 t)
S t tDt
St tI t
APV
(1 i ) t (1 i ) t
t
(1
k
)
ud
d
d
t 1
t 1
t 1
T
ST TVT
S t LPt
S
C
S
RF
S
CL
(1 i ) t
0
0
0
0
0
0
(1 k ud )T
d
t 1
T
T
St (Rt OCt )(1 t)
St tDt
St tI t
APV
t
t
t
(1
k
)
(1
i
)
(1
i
)
ud
d
d
t 1
t 1
t 1
T
ST TVT
St LPt
S
C
S
RF
S
CL
0
0
0
0
0
0
T
t
(1 k ud )
(1
i
)
d
t 1
T
T
St (Rt OCt )(1 t)
St tDt
St tI t
APV
t
t
t
(1
k
)
(1
i
)
(1
i
)
ud
d
d
t1
t1
t1
T
ST TVT
St LPt
10
T
St (Rt OCt )(1 t) T St tDt
St tIt
APV
t
t
t
(1
k
)
(1
i
)
(1
i
)
ud
d
d
t1
t1
t1
T
ST TVT
St LPt
12
t
t
t
(1
k
)
(1
i
)
(1
i
)
ud
d
d
t 1
t 1
t 1
T
ST TVT
St LPt
S
C
S
RF
S
CL
(1 i ) t
0
0
0
0
0
0
(1 k ud )T
d
t 1
13
14
Sensitivity Analysis
In sensitivity analysis, different estimates are used as
inputs for APV calculation.
Sensitivity analysis gives the manager a more complete
picture of the planned capital investment.
15
16
Other Information
Madrid sales affiliate accumulated a net amount of
750,000 from its operations, which can be used to
partially finance construction cost (this is an example of
RF);
The accumulated funds (750,000) were earned under special
tax concessions and taxed at a marginal rate of 20%.
18
Calculating APV
Initial cost of the project in $:
St S 0 * (
1.03 t
)
1.021
0
1
2
3
4
5
6
St
New
New Sales Sales
Lost
Lost Sales Sales
Beforetax OCF
PV of
Afterafter-tax
tax OCF OCF
Units
Units
1.32
$ (i=12%)
9,600
1.3316 25,000
1,331,63
6 10,080
363,384 968,252
1.3434 28,000
1,536,17
5 10,584
1.3552 31,360
1,772,13
1 11,113
1.3672 35,123
2,044,33
1 11,669
654,603
1.3792 39,338
2,358,34
0 12,252
686,465
1.3914 44,059
2,720,58
1 12,865
3,138,46
629,364 561,932
20
Year
St
(t)
1
2
3
4
5
6
7
8
1.3316
1.3434
1.3552
1.3672
1.3792
1.3914
1.4036
1.4160
Dt
tDt
PV of tDt
( id=8%)
687,500
687,500
687,500
687,500
687,500
687,500
687,500
687,500
320,425
323,249
326,099
328,973
331,873
334,799
337,750
340,727
296,690
277,134
258,868
241,805
225,867
210,980
197,074
184,084
1,892,502
21
St
Loan
Outstanding Principal
Interest
Total Loan
PMT
(t)
PV of LP
(id=8%)
1.3200
4,000,000
1.3316
3,500,000
500,000
200,000
932,145
863,097
1.3434
3,000,000
500,000
175,000
906,777
777,415
1.3552
2,500,000
500,000
150,000
880,890
699,279
1.3672
2,000,000
500,000
125,000
854,476
628,065
1.3792
1,500,000
500,000
100,000
827,528
563,202
1.3914
1,000,000
500,000
75,000
800,038
504,160
1.4036
500,000
500,000
50,000
771,999
450,454
1.4160
- 500,000
25,000
743,404
401,638
22
S0CL0
(1 + i )
t=1
St LPt
St
(t)
Interest
Interest
1.3316
200,000
266,327
0.55
51,268
47,470
1.3434
175,000
235,090
0.55
45,255
38,799
1.3552
150,000
203,282
0.55
39,132
31,064
1.3672
125,000
170,895
0.55
32,897
24,181
1.3792
100,000
137,921
0.55
26,550
18,069
1.3914
75,000
104,353
0.55
20,088
12,659
1.4036
50,000
70,182
0.55
13,510
7,883
1.4160
25,000
35,400
0.55
6,815
3,682
183,807
24
25
Calculating APV
APV=5,374,685+1,892,502+392,689+183,807+185,6257,260,000
=$769,308
Accept this project!
Note: if the APV is negative or close to zero, we would need
to consider the PV of the after-tax terminal cash flow.
27
Learning Outcomes
Discuss why the APV capital budgeting framework is
useful for analyzing foreign capital expenditures
Discuss how to handle a concessionary loan in the APV
model
Conduct APV analysis