Question

1. What are some factors/things to consider when tackling an international capital budgeting problem?

2. What tools would you use or can you use to make decisions in an international capital budgeting process?

3. How do you obtain the discount rate for an international capital budgeting problem?

Answer 1

Answer to question no 1 :-

Factors affecting international budgeting problem :-

1) Exchange Rate fluctuations

2) International financing arrangements of capital

3) International taxation

4) Accounting method

5) Spot and forward rates

6) Country risk and political risk.

Answer to question no 2 :-

Tools used :-

There are five main methods for capital budgeting that is payback period , net present value method , probability index , internal rate of return and accounting rate of return

However the best method for international capital budgeting is NPV method .

In this method the cash inflow expected at different periods of time is discounted at a particular rate .

The present value of cash inflow are compared to the original investment .

If the difference between them is positive then accepted ,else rejected.

Answer to question no 3 :-

In general cases the discount rate is

Kw = aKe +Kd(1-a)(1-t)

where business risk is constant and debt equity ratio remains same

The NPV is the opportunity cost of WACC

But in international capital budgeting these two things are changed .

Thus now an adjusted NPV is used with two adjustment :-

1- Project evaluation is carried out with cost of equity of firm

2) Present value of any cash flows such as subsidies and capital financing would be factored using special discount rates .