Question

(a) Why should capital budgeting for subsidiary projects be assessed from the parent’s perspective? What additional factors that normally are not relevant for a purely domestic project deserve consideration in multinational capital budgeting?

(b) Briefly explain how interest rate risk can be hedge through an interest rate swap?

(Please provide detailed answers)

Answer 1

A. Capital budgeting for subsidiary project should be assessed from the parents perspective because those subsidiary projects are to be incorporated into the books of the parents and the discount rate should be also applicable according to the business of the parents because these amounts which are generated through cash flows of the subsidiaries are to be incorporated into the book value of the parent.

When there would be a purely Domestic Project then it can be advisable for adoption of the the discounting rate for the subsidiaries. Domestic factors who will not be considered for multinational capital budgeting would be discounting rate related to the company specific and all the macro factors which should be e related to the domestic company like inflation and interest rates and exchange rates.

B.interest rate risk can be hedged through interest rate swap because it is involved with exchange of fixed leg of payment with the floating leg of payments and if an individual has to receive either of them he will be swap through other leg and he will protect himself through any kind of interest rate fluctuation in the future.

For example, if an individual has to receive fixed leg of interest payment, then he would be hedging it through floating leg of interest payment by entering into a interest rate swap.