Multinational Capital Budgeting

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Multinational Capital Budgeting (or parts of
chapter 16)
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Agenda

• Multinational capital budgeting.
• Project vs. parent capital budgeting?
• Adjust capital budgeting analysis of foreign
  project for risk.
• Case study evaluate a greenfield foreign project
• Real option analysis vs. DCF analysis.

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Multinational Capital Budgeting

• Analysis of cash in- out- flows associated w/
  prospective long-term investment projects.
• Follows same steps as domestic budgeting
• Identify initial capital invested at risk.
• Estimate cash flows over time (including terminal
  value/ salvage value).
• Identify appropriate discount rate for PV.
• Apply traditional NPV or IRR analysis.

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Capital Budgeting for foreign projects

• Parent cash flows must be distinguished from
  projects.
• Parent cash flows often depend on form of
  financing gt cannot separate operating
  financing cash flows.
• Stand alone subsidiary cash-flow can be worth,
  but add no value overall.
• Non-financial payments can generate cash flows to
  parent, e.g. licensing fees.
• Need to evaluate political risk, forex risk
  differing inflation rates.
• Segmented national capital markets create
  financial gain /costs.
• Host government subsidies complicates WACC
  computation.

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Project vs. Parent Valuation?

• Most firms evaluate foreign projects from both
  parent project viewpoints.
• Rule of thumb parent valuation shall have
  priority.
• MNE shall invest only if it can earn a
  risk-adjusted return greater than local
  competitors.
• Project valuation provides closer approximation
  of effect on consolidated EPS
• US firms consolidate subsidiaries w/ 50
  ownership/
• If ownership b/n 20 49 (I.e. affiliate) gt
  consolidate on pro-rate basis.
• Subsidiaries w/ lt20 ownership considered
  unconsolidated investment.

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Case Study Cemex in Indonesia

• Cementos Mexicanos (Cemex) considers greenfield
  investment in Indonesia plant (Cemex Indonesia)
• Presence in Southeast Asia.
• Strong prospects for infrastructure growth.
• Benefit from depreciation of Indonesian Rupiah
  (RP)
• Cemex functional currency US.
• Time to build 1 year
• Inflation rates 30 (Indonesia), 3 (US)
• Notice that we use the US inflation, not Mexicos
  one!

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Step I Cost of Capital Computation
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Debt Service Forex Gain/Loss
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Income Statement Assumptions

• Revenues
• Sales based on export.
• Cement will be sold in export market at 58/ton.
• Costs
• Direct cost RP 115,000/ton rising _at_ rate of
  inflation (30 p.a.).
• Additional production cost of RP20,000/ton
  rising _at_ rate of inflation (30 p.a.).
• Loading costs 2.00/ton rising _at_ inflation (3
  p.a.).
• Shipping costs 10/ton rising _at_ inflation (3
  p.a.).
• License fee 2 sales
• Sales, General, Admin Expenses 8 (growing _at_
  1 p.a.)

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Pro-forma Income Statement
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Project Viewpoint Capital Budget

• Cemex Indonesia free cash flows found by looking
  _at_ EBITDA, not EBT!
• Taxes calculated based on EBITDA.
• Terminal value (TV) calculated for continuing
  value of plant after year 5.
• TV calculated as perpetual net operating cash
  flow after year 5

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Capital Budget Project Viewpoint
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Parent Viewpoint Capital Budget

• Cash flows estimates are constructed from
  parents viewpoint
• Cemex must use its cost of capital, not projects
  one!
• Cemex WACC 11.98
• Cemex requires additional 6 for international
  projects gt discount rate will be 17.98
• This yields an NPV of -925.6 million (IRR
  1.84) which is unacceptable from the parents
  viewpoint

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Capital Budget Parent Viewpoint
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Sensitivity Analysis

• Political risk
• Risk of blocked funds.
• Risk of expropriation.
• Foreign exchange risk
• appreciation of US .
• depreciation of US .

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Real Option Analysis

• DCF analysis cannot capture value of strategic
  options, yet real option analysis allows this
  valuation
• Real option analysis includes valuation of
  project w/ future choices
• option to defer or abandon (timing option).
• option to alter capacity (expansion options).
• option to start up/ shut down (switching).
• option to learn.
• Real option analysis treats cash flows in terms
  of future value in a positive sense whereas DCF
  treats future cash flows negatively (on a
  discounted basis)
• The valuation of real options and the variables
  volatilities is similar to equity option math

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Things to remember

• Multinational capital budgeting.
• Project vs. parent capital budgeting?
• Adjust capital budgeting analysis of foreign
  project for risk.
• Case study evaluate a greenfield foreign project
• Real option analysis vs. DCF analysis.