Multinational capital budgeting can be based on similar concepts to those used in the purely domestic case using the net present value (NPV) analysis, in which project cash flows are discounted using the firm’s weighted average cost of capital, or the internal rate of return method which finds the rate of return equating project cash inflows with project costs.
Depending upon the information available, two alternative NPV methods are available. Both methods produce the NPV in domestic currency terms. For an American company investing
overseas, we can:
(a) Convert the project cash flows into dollars and then discount at a dollar discount rate to calculate the NPV in dollar terms, or
(b) Discount the foreign currency cash flows from the project at a discount rate for that currency and then convert the resulting NPV into a dollar NPV at the spot exchange rate. There are, however, some special considerations in the international case.
(a) For the purpose of assessing how expected performance compares with potential performance, it is necessary to compare the project’s net present value with those of similar host country projects. This involves measuring the cash flows in terms of the currency of the host country.
(b) A foreign project also needs to be evaluated on its net present value in respect of the funds which can be remitted to the parent. The purpose of this second stage is to evaluate whether the cash flow remitted justifies the cash invested from the home country.
(c) Cash flows from the subsidiary may come about through a variety of means, including licensing fees and payments for imports from the parent company.
(d) The possibility of differing national rates of inflation needs to be taken into account.
Additional factors: Additional factors to be taken into account when appraising overseas investments are as follows:
(a) Political interference by overseas governments, including exchange controls, extra charges on the profits of overseas companies and employment legislation could be a danger.
(b) Differences in tax systems (and accounting practices) may be significant.
(c) investor should allow for the extra risk associated with overseas investments, largely as a result of (a) and (b), as well as any foreign exchange risk through not matching foreign currency assets and liabilities, or not matching revenues and finance payments in the foreign currency.
(d) Some countries offer special finance incentives for investment in that country. (e) It might be better to export than to set up a foreign subsidiary.