International Financial ManagementBekaert 2eSolutionsCh15.docx
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International Financial ManagementBekaert 2eSolutionsCh15.docx
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InternationalFinancialManagementBekaert2eSolutionsCh15
Chapter15
InternationalCapitalBudgeting
questions
1.Cananinvestmentprojectofaforeignsubsidiarythathasapositivenetpresentvaluewhenevaluatedasastand-alonefirmeverberejectedbytheparentcorporation?
Assumethattheparentacceptsallprojectswithpositiveadjustednetpresentvalues.
Answer:
Yes,weknowthatcountriesimposewithholdingtaxesonthedividendsthatarerepatriatedfromsubsidiariestoparentcorporations.Thesetaxeslowerthevalueoftheprojecttotheparent.Theparentmustalsobeawareofthepossibilityoffutureproblemsaccessingtheforeignexchangemarketfromthesubsidiary’scountry.Ingeneral,politicalriskcouldbedifferentforasubsidiaryofamultinationalcorporationversusalocalstand-alonefirm.
2.Howdolicensingagreements,royalties,andoverheadallocationfeesaffectthevalueofaforeignproject?
Answer:
Licensingagreements,royalties,andoverheadallocationfeesaretruecoststothesubsidiaryortothestand-alonefirmthatwouldbeoperatingintheforeigncountryproducingandsellingtheproductsofthemultinationalcorporation.Thus,licensingagreements,royalties,andoverheadallocationfeesreducetheincomeintheforeigncountry.Nevertheless,thesecashflowsprovideprofittotheparentcorporation.Licensingagreementsandroyaltiesprovidepureprofittotheparentasnocostsareincurred,andoverheadfeesprovidenetprofitastheycovercostsincurredbytheparent.Thus,thesecashflowsarequitevaluabletotheparent.
3.Whydoesanadjustednetpresentvalueanalysistreatthepresentvalueoffinancialsideeffectsasaseparateitem?
Isn’tinterestexpensealegitimatecostofdoingbusiness?
Answer:
Theadjustednetpresentvalueapproachtocapitalbudgetingstartsbyvaluingthefreecashflowstotheall-equitycashfirm.Itthenaddsothersourcesofvalueassociatedwithhowthefirmisfinanced.Asintheweightedaveragecostofcapital(WACC)approachinChapter16,thenumeratorcashflowsarethefreecashflowstotheallequityfirm.IncontrasttoWACCanalysis,whichdiscountsthesecashflowswithadiscountratethatisaweightedaverageoftheafter-taxrequiredreturnonthedebtandtherateofreturnontheleveredequity,theANPVanalysisusestherateofreturnontheunleveredassetstogettheall-equityvalue.Studentssometimesthinkthatthedeductibilityofinterestasabusinessexpenseisthereforemissing,andtheywanttoreducetheall-equityfreecashflowsbytheafter-taxinterestpayments.ThismissesthefactthatthevalueoftheinteresttaxshieldsisbeingaddedasaseparatesourceofvalueinANPV,whereasitisincludedinWACC.Also,itmissesthefactthatwhentheequityholdersleverthefirm,theygettheprincipalonthedebtupfrontanddon’thavetoputasmuchequityintothefirmforitsinvestments.Thepresentvalueofthefuturecashoutflowsforinterestpaymentsandrepaymentofprincipalequaltheinitialvalueoftheprincipal,inwhichcaseitisonlythetaxshieldthatneedstobevalued.ANPVdoesthisseparately.
4.Whatismeantbythenetpresentvalueofthefinancialsideeffectsofaproject?
Answer:
Generally,theseeffectsarisefromthecostsofissuingsecurities,thetaxesortaxdeductionsassociatedwiththetypeoffinancinginstrumentused(includingthetaxdeductibilityoftheinterestpaidonthedebt),thecostsoffinancialdistress,andtheavailabilityofsubsidizedfinancingfromgovernments.
5.Whyisitcostlytoissuesecurities?
Answer:
Theinvestmentbankerswhohandletheissuingofsecuritieseithertothepublicortoprivateinvestorsarefinancialintermediaries,andtheymustbecompensatedfortheuseoftheirscarceresources.Thiscompensationincludesamonetaryfee,butitalsooftenincludesanunderwritingdiscount,orspread.Theunderwritingdiscountbetweenwhatthecorporationreceivesfromissuingthesecuritiesandwhatthepublicpaysforthesecuritiesisoftenalargepartofthecompensationoftheinvestmentbankthatunderwritestheissue.
6.Whatisaninteresttaxshield?
Howdoyoucalculateitsvalue?
Answer:
Theinteresttaxshieldonadebtisthevalueoftheabilitytodeductinterestasabusinessexpense.Therefore,atapointintimeitisequaltothecorporatetaxratetimestheamountofinterest,
.Thistaxdeductionisdiscountedatthestateddebtrate,whichisthemarketdebtrateassociatedwiththatdebt.Thus,thediscountedpresentvalueofaperpetualinteresttaxshieldis
7.Whatisaninterestsubsidy?
Howdoyoucalculateitsvalue?
Answer:
Interestsubsidiesarisewhengovernmentsarewillingtolendtocorporationsatbelowmarketinterestrates.Suchsubsidiesaddvaluetoaproject.Theappropriatediscountrateforaninterestsubsidyisthemarket’srequiredrateofreturnonthedebtofthecorporationbecausethecorporationisjustaslikelytodefaultonasubsidizedloanfromthegovernmentasitisonanormalloanatmarketinterestrates.SupposethatthegovernmentletsacorporationborrowaprincipalofDforoneperiodatasubsidizedinterestrateofrS Thevalueofaloanatasubsidized,below-market,interestratehastwocomponents: thepresentvalueoftheinterestsubsidy,whichisthedifferencebetweentheinterestpaidonamarketloanandtheinterestonthesubsidizedloan,plusthepresentvalueoftheactualinteresttaxshield.Inbothcases,thepresentvalueistakenatthemarket’srequiredrateofreturnonthedebt. 8.Whataregrowthoptions? Provideanexampleofoneinaninternationalcontext. Answer: Agrowthoptionariseswhenafirmundertakesaprojectandobtainsanoptiontodoanotherprojectinthefuture.Theoptiontodothesecondprojectaddsvaluetothefirstproject.Agrowthoptionmightincludeafirm’sabilitytosellanewproductthatissuccessfulinthedomesticmarketintheinternationalmarketplace.Growthoptionsarespecificexamplesofrealoptionsthatalsoincludetheabilityofafirmtoshutdownaplantoramineuntiloperatingconditionsimproveortodelayanimportantoperatingdecisionuntilmoreinformationcanbegathered.Realoptionsarevaluable. 9.WhatisthedifferencebetweenEBITandNOPLAT? Answer: TheacronymEBITisearningsbeforeinterestandtaxes.Itrepresentsthebefore-taxoperatingprofitofthefirm.TheacronymNOPLATisnetoperatingprofitlessadjustedtaxes.ItisfoundbytakingthetaxesoutofEBITthatwouldbepaidbytheall-equityfirm.Itisthereforetheafter-taxoperatingprofitoftheall-equityfirm. 10.Whyisitimportanttounderstandandmanagenetworkingcapital? Answer: Thestockofnetworkingcapitalistheamountofinventory,cash,andaccountsreceivableminusaccountspayablethatthefirmmusthaveonhandtorunitsbusiness.Ifthebusinesscanberunwithalowernetworkingcapital,thisamountofassetscouldbegiventoinvestors.Conversely,increasesinnetworkingcapitaluseafter-taxprofitsthatthefirmcouldotherwiseusetofinancecapitalexpendituresorpaytoinvestors.Assuch,changesinnetworkingcapitalareinvestmentsthatthefirmmakesinitsfutureprofitability. 11.WhatdoesCAPXmean,andwhyisitafirm’sengineofgrowth? Answer: CAPXisanacronymthatisshortforcapitalexpenditures.Theseareinvestmentsthatthefirmismakinginphysicalplantandequipmentthatwillproduceoutputinthefuture.Consequently,ifthefirmwantstogrow,itwillhavetodoCAPX,andinthissense,CAPXisthefirm’sengineofgrowth. 12.WhyisitsometimesassumedthatCAPXequalsdepreciationinthelaterstagesofaproject? Howdoesexpectedinflationaffectthisassumption? Answer: Asaprojectmatures,therearenomoreplannedinvestmentsinwhichcasethescaleoftheprojectisfixed.But,thephysicalplantandequipmenthaveaneconomiclifetimeandmustbereplaced.Ifaccountingdepreciationmatcheseconomicdepreciation,settingCAPXequaltodepreciationisappropriate.Youshouldbeawarethataccountingdepreciationoftenfailstomatcheconomicdepreciationbecauseofinflation.Thehighertherateofinflation,themoreseverethisproblemisunlesstheaccountingdepreciationisindexedtoinflationinsomeway.BecauseCAPXwillbespentonrealplantandequipment,thenominalamountofexpendituresmaybesomewhatgreaterthantheamounttheaccountsareallowedtodeductforthebookvalueofdepreciation. 13.Whatistheterminalvalueofaproject? Howisitcalculated? Answer: Theterminalvalueofaprojectisthepresentdiscountedvalueofallfuturefreecashflowsintheyearsbeyondanexplicitforecastinghorizon.Ifwegenerateexplicitforecastsoffreecashflowsforthenext10years,theterminalvalueisthepresentdiscountedvalueoffreecashflowsinyears11toinfinity.Onetypicallyassumesthatfuturefreecashflowswillgrowattherateg,andthediscountratefortheseperpetualcashflowsisr.Thestartingvalueinyear11is(1+g)higherthantheexpectedfreecashflowsinyear10.Fromtheperpetuityformulaforagrowingcashflow,weknowthat Aftercalculatingtheterminalvalueinyear10,thatquantitymustthenbediscountedtoyear0bymul
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