Question

1. Brilliant Berhad, a Singaporean company is contemplating on opening new subsidiary in Manila. After thorough analysis, the management found out that the NPV from the perspective of Singaporean’s parent company is unfavourable compared to NPV from the perspective of subsidiary in Manila. Discuss the difference between performing the capital budgeting analysis from the parent firm’s perspective as opposed to the subsidiary’s perspective.

2. Mashimoto Electric is based in Osaka, Japan. Mashimoto Electric has a subsidiary in Singapore that generates SGD 50 million in annual sales. Any earnings generated by the subsidiary are reinvested to support its operations. Benzai Electric is the close competitor of Mashimoto Electric. Benzai Electric is a local Japanese company located in Japan with annual export sale to Singapore of about SGD 50 million. Based on the information provided, which firm is subject to a higher degree of translation exposure? Justify your answer with thorough explanation on both company.

Answer 1

A. Capital budgeting decision making from the perspective of parent is completely different of that of a perspective of subsidiary because the cost of the capital will be different for both of the companies and the return on the capital will also be different for both of the companies and there would also be a transaction and translation exposure along with Economic exposure which are needed to be discounted in to the overall weighted average cost of capital when computing it for the parent, so if it is not favourable from the perspective of the parent then the project should not be undertaken because there are various kinds of risk and exposures which are needed to be discounted in overall rate of return while determination of cost of capital.

B) Translation exposure means translating the books of accounts of the subsidiary into the books of accounts of parent, so the company which is having a subsidiary in the Singaporean market will be having higher translation risk compared to that company who is exporting into the Singaporean market because the company which will be exporting does not have translation risk, instead it will be having a transaction risk.