Question

Discuss how capital budgeting differs between domestic-only and multinational corporations. Briefly describe the two approaches we used for a multinational corporation and how they determine whether or not you would accept or reject a project

Answer 1

The following are the key differences: -

1. Currency risks need to be managed too in case of multi-national capital budgeting. When one has an operation in another country, cash inflows and outflows are often handled in the local currency. Unfortunately, the conversion rates are constantly changing. Multi-national capital budgeting should cover these risks by using currency hedges. This might involve buying futures on the currency, selling options, or investing in some type of derivatives.
2. Different legal and tax regulations must be taken care of too. The tax laws on corporations are different for every country. Multi-national capital budgeting should take into account the tax laws of several countries so as to maximize the profits and cash flows.
3. Financial reporting rules may also be different. This can mean that the same type of report could be prepared differently and have other interpretations.
4. Borrowing costs are not the same too. The difference in the interest rates in the two countries, the borrowing costs, the repayment terms, and the type of collateral requirements in the two countries must be taken account of.
5. Raising Capital may be different as well. In a foreign country, raising capital might not be so easy. Regulations will be different. The rights of shareholders could be stiffer. The cost of capital might be higher. All of these issues add to the complexity of doing business in foreign countries.
6. There may be political risks from foreign governments too.

The question doesn't provide the information about two approaches used for MNCs. From the perspective of the firm, project value is still the discounted present value of expected cash flows from the investment discounted at an appropriate risk-adjusted cost of capital. Projects should be undertaken only if the present value of the expected future cash flows from the investment exceeds the cost of the investment. The following adjustments need to be made: -

1. Exchange rate fluctuations: - Since it is difficult to accurately forecast exchange rates, different scenarios can be considered together with their probability of occurrence.
2. Inflation: - Although price/cost forecasting implicitly considers inflation, inflation can be quite volatile from year to year for some countries.
3. Financing adjustments: - 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.