Multinational Business Finance
This article will focus on capital budgeting as it applies to multinational corporations. Capital budgeting could be the result of purchasing assets that are new for the organization or getting rid of some of the current assets in order to be more efficient. Capital budgeting for the multinational corporation presents many problems that are rarely found in domestic capital budgeting. There will be a review of recommendations that could assist financial analysts with conducting a cost benefit analysis and reviewing cash flow from the perspective of the parent corporation and its subsidiaries.
Keywords Capital Budgeting; Capital Costs; Chief Financial Officer; Discounted Cash Flow Analysis; Expropriation; International Capital Budgeting; Net Present Value Technique; Rates of Return; Risk Adjusted Discount Rate; Transfer Pricing
International Business: Multinational Business Finance
Many organizations charge the finance department with overseeing the financial stability of the organization. The chief financial officer (CFO) may lead a team of financial analysts in determining which projects deserve investment. To do this, an organization undertakes capital budgeting; a process that frequently involves conducting a cost-benefit analysis. A cost-benefit analysis comprises a comparison between the cash inflows (benefits) and outflows (costs) in order to determine which is greater. Capital budgeting could result in the purchasing of assets that are new for the organization or the removal of some of the current assets in order to be more efficient. The finance team is charged with evaluating (1) which projects would be good investments, (2) which assets would add value to the current portfolio, and (3) how much the organization willing to invest into each asset.
In order to answer the questions about potential assets, there are a set of components to be considered in the capital budgeting process. The four components are initial investment outlay, net cash benefits (or savings) from the operations, terminal cash flow, and net present value (NPV) technique. Most of the literature discusses how the capital budgeting process operates in the traditional, domestic environment. However, as the world moves to a more global economic environment, consideration needs to be made as to how multinational corporations will conduct the capital budgeting process when operating in countries outside of their home base.
International capital budgeting refers to when projects are located in host countries other than the home country of the multinational corporation. Some of the techniques (i.e. calculation of net present value) are the same as traditional finance. However, "capital budgeting for a multinational is complicated because of the complexity of cash flows and financing options available to the multinational corporation" (Booth, 1982, p. 113). Capital budgeting for the multinational corporation presents many problems that are rarely found in domestic capital budgeting (Shapiro, 1978; Ang & Lai, 1989).
Financial analysts may find that the analysis of foreign projects is more complex than domestic projects due to the need to:
- Distinguish between parent cash flow and projects cash flow Multinationals will have the opportunity to evaluate the cash flow associated with projects from two approaches. They may look at the net impact of the project on their consolidated cash flow or they may treat the cash flow on a stand alone or unconsolidated basis. The theoretical perspective asserts that the project should be evaluated from the parent company's viewpoint since dividends and repayment of debt is handled by the parent company. This action supports the notion that the evaluation is actually based on the contributions that the project can make to the multinational's bottom line.
Some organizations may want to evaluate the project from the subsidiary's (local) point of view. However, the parent company's viewpoint should supersede the subsidiary's point of view. Multinational corporations tend to compare their projects with the subsidiary's projects in order to determine where their investments should go. The rule of thumb is to only invest in those projects that can earn a risk-adjusted return greater than the local competitors performing the same type of project. If the earnings are not greater than the local competitors, the multinational corporation can invest in the host country's bonds since they will pay the risk free rate adjusted for inflation.
Although the theoretical approach is a sound process, many multinationals tend to evaluate their projects from both the parent and project point of view because of the combined advantages. When looking from the parent company's viewpoint, one could obtain results that are closer to the traditional net present value technique. However, the project's point of view allows one to obtain a closer approximation of the effect on consolidated earnings per share. The way the project is analyzed is dependent on the type of technique utilized to report the consolidated net earnings per share.
- Recognize money reimbursed to parent company when there are differences in the tax system The way in which the cash flows are returned to the parent company has an effect on the project. Cash flow can be returned in the following ways:
- Dividends — It can only be returned in this form if the project has a positive income. Some countries may impose limits on the amounts of funds that subsidiaries can pay to their foreign parent company in this form.
- Intrafirm Debt — Interest on debt is tax deductible and it helps to reduce foreign tax liability.
- Intrafirm Sales — This form is the operating cost of the project and it helps lower the foreign tax liability.
- Royalties and License Fees — This form covers the expenses of the project and lowers the tax liability.
- Transfer Pricing — This form refers to the internally established prices where different units of a single enterprise buy goods and services from each other.
- Analyze the use of subsidized loans from the host country since the practice may complicate the capital structure and discounted rate The host country may target specific subsidiaries in order to attract specific types of investment (i.e. technology). Subsidized loans can be given in the form of tax relief and preferential financing, and the practice will increase the net present value of the project. Some of the advantages of this practice include (1) adding the subsidiary to project cash inflows and discount, (2) discounting the subsidiary at some other rate,...
(The entire section is 3098 words.)