Question

1a. How does forecasting cash flows for a multinational project differ from forecasting cash flows for a US based project?

b. Describe one way the required return for the project located in a foreign country can be determined if the required return for a similar project located in the US is known.

c. When determining the required return for a capital budgeting project located in a foreign country, why does it matter whether the capital market in that foreign country is integrated with the world market or is segmented? How does the required return in a segmented market differ from that in an integrated market?

Answer 1

Part a)

Introduction: Domestic Project tend to restrict their operations to the country of origin, while multinational Projects in more than two countries. Companies expand globally for many reasons, mostly to obtain new markets, cheaper resources and reduction in operational costs, all of which significantly affect financial management.

Coordinating and controlling worldwide operations can be complicated by the legal and economic systems specific to each country. Some practices that are routine in one country may be illegal in another. For example, paying an incentive to facilitate licensing in one country could be considered a bribe in another. Multinational corporations must learn how to adapt to differences in financial methods and customs. Unlike domestic firms, these corporations have financial obligations to foreign countries, which complicates tax reporting, hence difference in Cash Flows.

Why the Difference in Cash Flow for a multinational Project and US based Project:

Exchange rate fluctuations: A domestic project in the US may not have to face Exchange rate fluctuation as closely as a multinational project has to. This makes it a bit complicated for a multinational project to forcast cash flows accurately a small change in exchange rate can cause a great deal of effect on the net cash flow.

Inflation: Although price/cost forecasting implicitly considers inflation, inflation can be quite volatile from year to year for some countries. being in US will not have the effect of inflation difference of any ther country and it will not be a factor for consideration. but for multinational project it plays a big difference.

Financing arrangement: Financing costs are usually captured by the discount rate. However, when foreign projects are partially financed by foreign subsidiaries, a more accurate approach is to separate the subsidiary investment and explicitly consider foreign loan payments as cash outflows.

Blocked funds: Some countries require that the earnings generated by the subsidiary be reinvested locally for at least a certain period of time before they can be remitted to the parent.

Uncertain salvage value: Since the salvage value typically has a significant impact on the project’s NPV, the MNC may want to compute the break-even salvage value.

Host government incentives: These should also be incorporated into the analysis fro forcast of cash flows, many a countries provide for setting up projetcs for business and infrastructure development, which can positively effect the cash flows.

Real options: Some projects contain real options for additional business opportunities. The value of such a real option depends on the probability of exercising the option and the resulting NPV.

Tax differentials; Tax difference make a great impact on multinational projects it may differ from the rates in US.

Role of Government: Although many countries encourage foreign investment by providing incentives, the government's policy isn't the only determinant of competition. Financial management in a multinational corporation can be significantly affected by high levels of corruption, inefficiency and bureaucracy when the company has to deal with some foreign government officials. Unlike financial management in companies that operate domestically, a multinational often has to deal with burdensome and unpredictable regulations governing licensing, tariffs and taxes imposed by the host government.

Political Risk: Multinational corporations may have operations in countries that experience political instability. A change of government may come with new policies that make it impossible to operate profitably. For example, the new government may come up with nationalization programs that restrict money movement from the country. This can be a major challenge for financial management that relies on foreign exchange to ensure the company's continued global operations. Such political risk is typically not experienced on the domestic financial management front.

Banking Regulations: Multinational financial managers have to deal with global banking institutions that have their own challenges. Some banks experience liquidity problems because of prevailing economic conditions in their countries. Other banks in some emerging economies are heavily regulated by their respective countries' central governments rather than by market forces, which influences interest rates. In addition, many multinationals find themselves operating in countries where the banking industry is subject to the policies of the International Monetary Fund, which many businesses consider unfriendly to their needs.

Credit: Excessive debt can ruin the multinational corporation's chances of growth and expansion in the foreign markets. Financial management has to ensure the multinational has ample credit for routine business-to-business operations. If the corporation has to get part of its financing for overseas projects from the countries where it has operations, it will be vulnerable to lending rates dictated by the condition of the economy in those countries.

Part b) if the rquired rate of return is known for a project in the US it becomes easier to determine the rate of return for a similar project located in a forign country all you have to do is take all the diifferent factors in Part a and make adjustment to the Input factors after making the required changes in values..

Part C. The reason why its important to know that whether the capital market i integrated with the world market or not is because an integrated market is an out come of globle information which is well adjusted of all the factors that can possibly affect it. which means better liquidity, better identification, pricing and trading of risk which help in accurate calculation of rate of Return,

it matters whether a market is integrated or not because a segmented market gives standalone results and absolute values for calculation of required rates which may of may not be correct and can lead to wrong capital budgeting decesions.

a segmented market is based upon information existing in that nation only but a well integratedmarket is affetded bt more amount of informatio and is well adjusted of the changes in global market so the calculation based on integrated markets are more accurate.