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    Factors Affecting MNC Capital Budgeting

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    Asif Rahman
    1) The document analyzes the cash flows and profitability of a proposed capital investment by a parent company in a subsidiary located in a foreign country. 2) Under the initial arrangement, the project generates a positive NPV of $2.2 million for the parent company over 4 years. 3) An alternative financing arrangement is then considered where the parent provides more initial funding, eliminating the subsidiary's lease expense. This increases the NPV to $1.1 million for the parent.

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    Factors Affecting MNC Capital Budgeting

    Uploaded by

    Asif Rahman
    247 views13 pages
    1) The document analyzes the cash flows and profitability of a proposed capital investment by a parent company in a subsidiary located in a foreign country. 2) Under the initial arrangement, the project generates a positive NPV of $2.2 million for the parent company over 4 years. 3) An alternative financing arrangement is then considered where the parent provides more initial funding, eliminating the subsidiary's lease expense. This increases the NPV to $1.1 million for the parent.

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    Factors affecting Capital Budgeting of MNCs

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    1) The document analyzes the cash flows and profitability of a proposed capital investment by a parent company in a subsidiary located in a foreign country. 2) Under the initial arrangement, the project generates a positive NPV of $2.2 million for the parent company over 4 years. 3) An alternative financing arrangement is then considered where the parent provides more initial funding, eliminating the subsidiary's lease expense. This increases the NPV to $1.1 million for the parent.

    Copyright:

    © All Rights Reserved
    Download as XLSX, PDF, TXT or read online from Scribd
    Download as xlsx, pdf, or txt
    247 views13 pages

    Factors Affecting MNC Capital Budgeting

    Uploaded by

    Asif Rahman
    1) The document analyzes the cash flows and profitability of a proposed capital investment by a parent company in a subsidiary located in a foreign country. 2) Under the initial arrangement, the project generates a positive NPV of $2.2 million for the parent company over 4 years. 3) An alternative financing arrangement is then considered where the parent provides more initial funding, eliminating the subsidiary's lease expense. This increases the NPV to $1.1 million for the parent.

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    © All Rights Reserved
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    Exhibition: Multinational Capital Budget Analysis: Spartan, Inc.

    Year 0 Year 1
    1 Demand (units) 60,000
    2 Price per unit $350
    3 Total revenue=(1)*(2) $21,000,000
    4 Variable cost per unit $200
    5 Total Variable cost=(1)*(4) $12,000,000
    6 Annual lease expense $1,000,000
    7 Other fixed annual expenses $1,000,000
    8 Noncash expense (Depreciation) $2,000,000
    9 Total expenses =(5)+(6)+(7)+(8) $16,000,000
    10 Before-tax earnings of subsidiary =(3)-(9) $5,000,000
    11 Host government tax (20%) $1,000,000
    12 After-tax earnings of subsidiary $4,000,000
    13 Net cash flow to subsidiary=(12)+(8) $6,000,000
    S$ remitted by subsidiary
    14 (100% of net cash flow) $6,000,000
    15 Withholding tax on remitted funds (10%) $600,000
    16 S$ remitted after withholding taxes $5,400,000
    17 Salvage value
    18 Total cash to be remitted after withholding taxes $5,400,000
    19 Exchange rate of S$ $0.50
    20 Cash flows to parent $2,700,000
    21 Discount factor at 15% 0.8696
    22 PV of parent cash flows $2,347,826
    23 PV of total parent cash inflows $12,229,866
    24 Initial investment by parent/PV of total cash outflows $10,000,000
    25 NVP $2,229,866
    alysis: Spartan, Inc.

    Year 2 Year 3 Year 4


    60,000 100,000 100,000
    $350 $360 $380
    $21,000,000 $36,000,000 $38,000,000
    $200 $250 $260
    $12,000,000 $25,000,000 $26,000,000
    $1,000,000 $1,000,000 $1,000,000
    $1,000,000 $1,000,000 $1,000,000
    $2,000,000 $2,000,000 $2,000,000
    $16,000,000 $29,000,000 $30,000,000
    $5,000,000 $7,000,000 $8,000,000
    $1,000,000 $1,400,000 $1,600,000
    $4,000,000 $5,600,000 $6,400,000
    $6,000,000 $7,600,000 $8,400,000

    $6,000,000 $7,600,000 $8,400,000


    $600,000 $760,000 $840,000
    $5,400,000 $6,840,000 $7,560,000
    $12,000,000
    $5,400,000 $6,840,000 $19,560,000
    $0.50 $0.50 $0.50
    $2,700,000 $3,420,000 $9,780,000
    0.7561 0.6575 0.5718
    $2,041,588 $2,248,706 $5,591,747
    Exhibit: Analysis Using Different Exchange Rate Scenarios : Spartan, Inc.

    Year 0 Year 1 Year 2


    S$ remitted after withholding taxes (including salvage value) $5,400,000 $5,400,000
    Strong-S$ Scenario
    Exchange rate of S$ $0.54 $0.57
    Cash flows to parent $2,916,000 $3,078,000
    Discount factor at 15% 0.8696 0.7561
    PV of parent cash flows $2,535,652 $2,327,410
    PV of total parent cash inflows $14,875,754
    Initial investment by parent/PV of total cash outflows $10,000,000
    NVP $4,875,754
    Weak-S$ Scenario
    Exchange rate of S$ $0.47 $0.45
    Cash flows to parent $2,538,000 $2,430,000
    Discount factor at 15% 0.8696 0.7561
    PV of parent cash flows $2,206,957 $1,837,429
    PV of total parent cash inflows $9,981,243
    Initial investment by parent/PV of total cash outflows $10,000,000
    NVP -$18,757

    Note: 1. Exchange rate varies from year to year.


    2. In strong exchange rate scenario, the parent company get
    : Spartan, Inc.

    Year 3 Year 4
    $6,840,000 $19,560,000

    $0.61 $0.65
    $4,172,400 $12,714,000
    0.6575 0.5718
    $2,743,421 $7,269,271

    $0.40 $0.37
    $2,736,000 $7,237,200
    0.6575 0.5718
    $1,798,964 $4,137,893

    io, the parent company gets more US $ for each Singapore $ (S$), as Singapore $ (S$) is stronger in this scenario. The opposite happens in w
    ario. The opposite happens in weak S$ scenario.
    Exhibit: Analysis with an Alternative Financing Arrangement: Spartan, Inc.
    Year 0 Year 1
    1 Demand (units) 60,000
    2 Price per unit $350
    3 Total revenue=(1)*(2) $21,000,000
    4 Variable cost per unit $200
    5 Total Variable cost=(1)*(4) $12,000,000
    6 Annual lease expense $0
    7 Other fixed annual expenses $1,000,000
    8 Noncash expense (Depreciation) $2,000,000
    9 Total expenses =(5)+(6)+(7)+(8) $15,000,000
    10 Before-tax earnings of subsidiary =(3)-(9) $6,000,000
    11 Host government tax (20%) $1,200,000
    12 After-tax earnings of subsidiary $4,800,000
    13 Net cash flow to subsidiary=(12)+(8) $6,800,000
    S$ remitted by subsidiary
    14 (100% of net cash flow) $6,800,000
    15 Withholding tax on remitted funds (10%) $680,000
    16 S$ remitted after withholding taxes $6,120,000
    17 Salvage value
    18 Total cash to be remitted after withholding taxes $6,120,000
    19 Exchange rate of S$ $0.50
    20 Cash flows to parent $3,060,000
    21 Discount factor at 15% 0.8696
    22 PV of parent cash flows $2,660,870
    23 PV of total parent cash inflows $16,116,425
    24 Initial investment by parent/PV of total cash outflows $15,000,000
    25 NVP $1,116,425

    Note: 1. There is no lease payment. The parent will puch


    2. Parents initial investment is $15 million due to
    3. Salvage value at the end of 4 years is higher as
    rangement: Spartan, Inc.
    Year 2 Year 3 Year 4
    60,000 100,000 100,000
    $350 $360 $380
    $21,000,000 $36,000,000 $38,000,000
    $200 $250 $260
    $12,000,000 $25,000,000 $26,000,000
    $0 $0 $0
    $1,000,000 $1,000,000 $1,000,000
    $2,000,000 $2,000,000 $2,000,000
    $15,000,000 $28,000,000 $29,000,000
    $6,000,000 $8,000,000 $9,000,000
    $1,200,000 $1,600,000 $1,800,000
    $4,800,000 $6,400,000 $7,200,000
    $6,800,000 $8,400,000 $9,200,000

    $6,800,000 $8,400,000 $9,200,000


    $680,000 $840,000 $920,000
    $6,120,000 $7,560,000 $8,280,000
    $22,000,000
    $6,120,000 $7,560,000 $30,280,000
    $0.50 $0.50 $0.50
    $3,060,000 $3,780,000 $15,140,000
    0.7561 0.6575 0.5718
    $2,313,800 $2,485,411 $8,656,344

    yment. The parent will puchase the office.


    ment is $15 million due to parent financing.
    end of 4 years is higher as the offices will be sold too.
    Exhibit: Capital Budgeting with Blocked Funds: Spartan, Inc.
    Year 0
    S$ remitted by subsidiary
    Future Value Discount Factor
    Future Value at the end of Year 4
    S$ accumulated by reinvesting funds to be remitted
    Withholding tax on remitted funds (10%)
    S$ remitted after withholding taxes
    Salvage value
    Total cash to be remitted after withholding taxes
    Exchange rate of S$
    Cash flows to parent
    Discount factor at 15%
    PV of parent cash flows
    PV of total parent cash inflows $11,133,944
    Initial investment by parent/PV of total cash outflows $10,000,000
    NVP $1,133,944

    Notes: 1. Host country blocked funds to be


    2. Host country required that the ea
    3. The local reinvestment rate is equ
    4. As in this case, blocked funds can
    h Blocked Funds: Spartan, Inc.
    Year 1 Year 2 Year 3 Year 4
    $6,000,000 $6,000,000 $7,600,000 $8,400,000
    (1.05)^3 = 1.1576 (1.05)^2 = 1.1025 (1.05)^1 = 1.05 (1.05)^0 = 1
    $6,945,750 $6,615,000 $7,980,000 $8,400,000
    $29,940,750
    $2,994,075
    $26,946,675
    $12,000,000
    $38,946,675
    $0.50
    $19,473,338
    0.5718
    $11,133,944

    Host country blocked funds to be remitted till Year 4.


    Host country required that the earnings generated by the subsidiary be reinvested locally before those are remitted in Year 4.
    The local reinvestment rate is equal to marketable securities after-tax yield rate which is 5 percent annually.
    As in this case, blocked funds can penalize a project if the return on the reinvested funds is less than the required rate of return on the pro
    itted in Year 4.

    ed rate of return on the project.


    Exhibit: Capital Budgeting When Prevailing cash Flows Are Affected: Spartan,

    Year 0
    Cash flows to parent, ignoring impact of prevailing cash flows
    Impact of project on prevailing cash flows
    Cash flows to parent, incorporating impact of prevailing cash flows
    Discount factor at 15%
    PV of cash flows to parent (15% discount rate)
    PV of total parent cash inflows $9,374,887.88
    Initial investment by parent/PV of total cash outflows $10,000,000
    NVP -$625,112

    Note: 1. Project's cash flows might have impact o


    2. This exhibit assumed that some export
    ng cash Flows Are Affected: Spartan, Inc.

    Year 1 Year 2 Year 3 Year 4


    $2,700,000 $2,700,000 $3,420,000 $9,780,000
    -$1,000,000 -$1,000,000 -$1,000,000 -$1,000,000
    $1,700,000 $1,700,000 $2,420,000 $8,780,000
    0.8696 0.7561 0.6575 0.5718
    $1,478,261 $1,285,444 $1,591,189 $5,019,993

    oject's cash flows might have impact on prevailing cash flows of the parent. Sometimes, calculation of such impact accurately is a complex t
    is exhibit assumed that some export business by the parent company with the host country has been established and the impact of the pro
    pact accurately is a complex task.
    hed and the impact of the project on parent's prevailing cash flows is roughly considered.

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