Multinational Capital Budgeting Subsidiary versus Parent Perspective

Multinational Capital Budgeting Subsidiary versus Parent Perspective

•     Should the capital budgeting for a multi-national project be conducted from the viewpoint of  the subsidiary that will administer the project, or the parent that will provide most of the financing?

•     The results may vary with the perspective taken because the net after-tax cash inflows to the parent can differ substantially from those to the subsidiary.

Subsidiary versus Parent Perspective

The difference in cash inflows is due to:

•     Tax differentials

¤    What is the tax rate on remitted funds?

•     Regulations that restrict remittances

•     Excessive remittances

¤    The parent may charge its subsidiary very high administrative fees

•     Exchange rate movements

Remitting Subsidiary Earnings to the Parent

Subsidiary versus Parent Perspective

•     A parent’s perspective is appropriate when evaluating a project, since any project that can create a positive NPV for the parent should enhance the firm’s value.

•     However, one exception to this rule may occur when the foreign subsidiary is not wholly owned by the parent.

Input for Multinational

Capital Budgeting

The following forecasts are usually required:

1.           Initial investment

2.           Consumer demand

3.           Product price

4.           Variable cost

5.           Fixed cost

6.           Project lifetime

7.           Salvage (liquidation) value

Input for Multinational

Capital Budgeting

9.           Tax laws

10.         Exchange rates

11.         Required rate of return


Capital Budgeting

•     NPV           =          –  initial outlay


+ S cash flow in period t

t =1            (1 + k )t

+ salvage value

(1 + k )n

k = the required rate of return on the project

n = project lifetime in terms of periods

•     If NPV > 0, the project can be accepted.

Capital Budgeting Analysis

Period t

1.  Demand        (1)

2.  Price per unit           (2)

3.  Total revenue (1)´(2)=(3)

4.  Variable cost per unit        (4)

5.  Total variable cost (1)´(4)=(5)

6.  Annual lease expense      (6)

7.  Other fixed periodic expenses   (7)

8.  Noncash expense (depreciation)          (8)

9.  Total expenses (5)+(6)+(7)+(8)=(9)

10.            Before-tax earnings of subsidiary         (3)–(9)=(10)

11.            Host government tax        tax rate´(10)=(11)

12.            After-tax earnings of subsidiary (10)–(11)=(12)

Capital Budgeting Analysis

Period t

13.            Net cash flow to subsidiary         (12)+(8)=(13)

14.            Remittance to parent         (14)

15.            Tax on remitted funds       tax rate´(14)=(15)

16.            Remittance after withheld tax     (14)–(15)=(16)

17.            Salvage value (at project end)    (17)

18.            Exchange rate         (18)

19.            Cash flow to parent           (16)´(18)+(17)´(18)=(19)

20.            Investment by parent (at project start) (20)

21. Net cash flow to parent          (19)–(20)=(21)

22. PV of net cash flow to parent           (1+k) t´(21)=(22)

23.            Cumulative NPV     S(22)=(23)

Factors to Consider in Multinational Capital Budgeting

Exchange rate fluctuations. Different scenarios should be considered together with their probability of occurrence.

  Inflation. Although price/cost forecasting implicitly considers inflation, inflation can be quite volatile from year to year for some countries.

Factors to Consider in Multinational Capital Budgeting

Financing arrangement. Financing costs are usually captured by the discount rate. However, many foreign projects are partially financed by foreign subsidiaries.

  Blocked funds. Some countries may require that the earnings be reinvested locally for a certain period of time before they can be remitted to the parent.

Factors to Consider in Multinational Capital Budgeting

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

Impact of project on prevailing cash flows. The new investment may compete with the existing business for the same customers.

Host government incentives. These should also be considered in the analysis.