INERNAIONAL FINANCIAL MANAGEMEN Sevenh Eiion EUN / RESNICK 8- Copyrigh 25 by he McGraw-Hill Companies, Inc. All righs reserve. Copyrigh 27 by he McGraw-Hill Companies, Inc. All righs reserve. Inernaional Capial Bugeing 8 Chaper Eigheen INERNAIONAL Chaper Objecive: FINANCIAL MANAGEMEN his chaper iscusses he mehoology ha a mulinaional firm can use o analyze he Fourh Eiion invesmen of capial in a foreign counry. EUN / RESNICK 8- Copyrigh 27 by he McGraw-Hill Companies, Inc. All righs reserve. Chaper Ouline l Review of Domesic Capial Bugeing n Expece backgroun reaing l he Ajuse Presen Value Moel n Suggese backgroun reaing l Capial Bugeing from Paren Firm s Perspecive l Risk Ajusmen in he Capial Bugeing Process l Sensiiviy Analysis l Real Opions 8-2 Copyrigh 27 by he McGraw-Hill Companies, Inc. All righs reserve.
Review of Domesic Capial Bugeing. Ienify he SIZE an IMING of all relevan cash flows on a ime line. 2. Ienify he RISKINESS of he cash flows o eermine he appropriae iscoun rae. 3. Fin NPV by iscouning he cash flows a he appropriae iscoun rae. 4. Compare he value of compeing cash flow sreams a he same poin in ime. 8-3 Copyrigh 27 by he McGraw-Hill Companies, Inc. All righs reserve. Inernaional Capial Bugeing Firs possible recipe for inernaional managers:. Esimae fuure cash flows in foreign currency 2. Conver o U.S. ollars a he preice exchange rae 3. Calculae NPV using he U.S. cos of capial 8-4 Copyrigh 27 by he McGraw-Hill Companies, Inc. All righs reserve. Inernaional Capial Bugeing Example 6 2 5 3 2 3 π = 3% i $ = 5% π $ = 6% $.55265 S ($/ ) = Is his a goo invesmen from he perspecive of he U.S. shareholers? 8-5 Copyrigh 27 by he McGraw-Hill Companies, Inc. All righs reserve. 2
Inernaional Capial Bugeing: Example $33.6 6 2 5 3 year 2 years 3 years CF = ( 6) S ($/ ) =( 6) $.55265 = $33.6 8-6 Copyrigh 27 by he McGraw-Hill Companies, Inc. All righs reserve. Inernaional Capial Bugeing: Example $33.6 $3.7 6 2 5 3 8-7 year 2 years 3 years CF = ( 2) E[ S ($/ )] =? E[ S ($/ )] can be foun by appealing o PPP: E[S.6 ()] = S ($/ ).3 =.6.3 so CF = ( 2) ($.5687/ ) = $3.7 $.55265 = $.5687/ Copyrigh 27 by he McGraw-Hill Companies, Inc. All righs reserve. Inernaional Capial Bugeing: Example $33.6 $3.7 $292.6 6 2 5 3 year 2 years 3 years Similarly, CF 2 =.6 S ($/ ) ( 5) = $292.6.3 8-8 Copyrigh 27 by he McGraw-Hill Companies, Inc. All righs reserve. 3
Inernaional Capial Bugeing: Example $33.6 $3.7 $292.6 $8.7 6 2 5 3 year 2 years 3 years (.6) CF 3 = 3 S ($/ ) ( 3) = $8.7 (.3) 3 $3.7 $292.6 $8.7 NPV = $ 33.6 3 (.5) (.5) (.5) 2 = $7.3 8-9 Copyrigh 27 by he McGraw-Hill Companies, Inc. All righs reserve. Inernaional Capial Bugeing Secon possible recipe for inernaional managers:. Esimae fuure cash flows in foreign currency 2. Esimae he foreign currency iscoun rae 3. Calculae he foreign currency NPV using he foreign cos of capial 4. ranslae he foreign currency NPV ino ollars using he spo exchange rae 8- Copyrigh 27 by he McGraw-Hill Companies, Inc. All righs reserve. Foreign Currency Cos of Capial Meho 6 2 5 3 8- π = 3% i $ = 5% π $ = 6% $.55265 S ($/ ) = 2 3 Le s fin i an use ha on he euro cash flows o fin he NPV in euros. hen ranslae he NPV ino ollars a he spo rae. Copyrigh 27 by he McGraw-Hill Companies, Inc. All righs reserve. 4
Fining he Foreign Currency Cos of Capial: i Recall ha if he Fisher Effec hols here an abroa 8-2 ( ρ $ ) ( π $ ) = ( i $ ) ( i $ ) ( ρ $ ) = ( π $ ) ( i ) = ( ρ ) ( π ) an if he real ineres raes are he same, hen: ( i ) = ( i $ ) ( π ) ( π $ ) Copyrigh 27 by he McGraw-Hill Companies, Inc. All righs reserve. Inernaional Capial Bugeing Example 6 2 5 3 2 3 ( i ) = π = 3% i $ = 5% π $ = 6% 8-3 ( i $ ) ( π ) ( π $ ) $.55265 S ($/ ) = (.5) (.3) = =.75% (.6) NPV @.75% = 94.39 à 94.39 = $7.43 $.55265 Copyrigh 27 by he McGraw-Hill Companies, Inc. All righs reserve. Inernaional Capial Bugeing l You have wo equally vali approaches: n Change he foreign cash flows ino ollars a he FX raes expece o prevail. Fin he $NPV using he ollar cos of capial. n Fin he foreign currency NPV using he foreign currency cos of capial. ranslae ha ino ollars a he spo exchange rae. l You will ge he same answer eiher way. l Which meho you prefer is your choice. n Cavea: someimes easier o esimae CoC han FX raes 8-4 Copyrigh 27 by he McGraw-Hill Companies, Inc. All righs reserve. 5
Ajuse Presen Value l he res of his PDF file an he corresponing maerial in he E&R s Chaper 8 are No Exam Maerial (NEM) 8-5 Copyrigh 27 by he McGraw-Hill Companies, Inc. All righs reserve. 8-6 Review of Domesic Capial Bugeing he basic ne presen value equaion is CF V NPV = C = ( K) ( K) Where: CF = expece incremenal afer-ax cash flow in year, V = expece afer ax cash flow in year, incluing reurn of ne working capial, C = iniial invesmen a incepion, K = weighe average cos of capial. = economic life of he projec in years. Copyrigh 27 by he McGraw-Hill Companies, Inc. All righs reserve. Review of Domesic Capial Bugeing he NPV rule is o accep a projec if NPV CF V NPV = C ( K) ( K) = an o rejec a projec if NPV CF V NPV = C ( K) ( K) =. 8-7 Copyrigh 27 by he McGraw-Hill Companies, Inc. All righs reserve. 6
Review of Domesic Capial Bugeing For our purposes i is necessary o expan he NPV equaion. CF = ( R OC D I )( τ) D I ( τ) R is incremenal revenue OC is incremenal operaing coss D is incremenal epreciaion I is incremenal ineres expense τ is he marginal ax rae 8-8 Copyrigh 27 by he McGraw-Hill Companies, Inc. All righs reserve. 8-9 Review of Domesic Capial Bugeing For our purposes i is necessary o expan he NPV equaion. CF = ( R OC D I )( τ) D I ( τ) = NI D I ( τ) = ( R OC Dτ)( τ) D = NOI ( τ) D = ( R OC )( τ) τd = OCF ( τ) τd Copyrigh 27 by he McGraw-Hill Companies, Inc. All righs reserve. We can use Review of Domesic Capial Bugeing CF = OCF ( τ) τd o resae he NPV equaion as: NPV = CF V = ( K) ( K) OCF ( τ) τd NPV = V C = ( K) ( K) C 8-2 Copyrigh 27 by he McGraw-Hill Companies, Inc. All righs reserve. 7
he Ajuse Presen Value Moel OCF ( τ) NPV = τd V = ( K) ( K) ( K) C Can be convere o ajuse presen value (APV) OCF ( τ) APV = τd V = ( Ku) ( i) ( i) ( Ku) By appealing o Moigliani an Miller s resuls. τi C 8-2 Copyrigh 27 by he McGraw-Hill Companies, Inc. All righs reserve. he Ajuse Presen Value Moel OCF ( τ) APV = τd V = ( Ku) ( i) ( i) ( Ku) C he APV moel is a value aiiviy approach o capial bugeing. Each cash flow ha is a source of value o he firm is consiere iniviually. Noe ha wih he APV moel, each cash flow is iscoune a a rae ha is appropriae given he riskiness of he cash flow. τi 8-22 Copyrigh 27 by he McGraw-Hill Companies, Inc. All righs reserve. Domesic APV Example Consier a projec of he Pearson Company, he iming an size of he incremenal afer-ax cash flows for an all-equiy firm are: -$, $25 $25 $375 $5 2 3 4 he unlevere cos of equiy is r = %: $25 $25 $375 $5 NPV% = $, 2 3 (.) (.) (.) (.) NPV % = $56.5 he projec woul be rejece by an all-equiy firm: NPV <. 4 8-23 Copyrigh 27 by he McGraw-Hill Companies, Inc. All righs reserve. 8
Domesic APV Example (coninue) l Now, imagine ha he firm finances he projec wih $6 of eb a r = 8%. l Pearson s ax rae is 4%, so hey have an ineres ax shiel worh τ I =.4 $6.8 = $9.2 each year. he ne presen value of he projec uner leverage is: APV = NPV NPVF 4 $9.2 APV = $56.5 (.8 8-24 = ) APV = $ 56.5 63.59 = $7.9 So, Pearson shoul accep he projec wih eb. Noe ha wih he APV moel, each cash flow is iscoune a a rae ha is appropriae o he riskiness of he cash flow. Copyrigh 27 by he McGraw-Hill Companies, Inc. All righs reserve. Domesic APV Example (coninue) l Noe ha here are wo ways o calculae he NPV of he loan. Previously, we calculae he PV of he ineres ax shiels. Now, le s calculae he acual NPV of he loan: 8-25 NPV NPV loan loan 4 $6.8 (.4) $6 = 6 (.8) (.8) $ 4 = = $63.59 APV = NPV NPV loan APV = $ 56.5 63.59 = $7.9 Which is he same answer as before. Copyrigh 27 by he McGraw-Hill Companies, Inc. All righs reserve. Capial Bugeing from he Paren Firm s Perspecive l Donal Lessar evelope an APV moel for a MNC analyzing a foreign capial expeniure. he moel recognizes many of he pariculars peculiar o foreign irec invesmen. APV = 8-26 = SV ( K ) u SOCF ( τ) ( K ) S C u = SτD ( i ) S RF S CL = = SLP ( i ) Copyrigh 27 by he McGraw-Hill Companies, Inc. All righs reserve. SτI ( i ) 9
Capial Bugeing from he Paren Firm s Perspecive APV = = SV ( K ) u SOCF ( τ) ( K ) S C u he operaing cash flows mus be ranslae back ino he paren firm s currency a he spo rae expece o prevail in each perio. = SτD ( i ) S RF S CL = = SτI ( i ) SLP ( i ) he operaing cash flows mus be iscoune a he unlevere omesic rae 8-27 Copyrigh 27 by he McGraw-Hill Companies, Inc. All righs reserve. Capial Bugeing from he Paren Firm s Perspecive APV = = SV ( K ) u SOCF ( τ) ( K ) S C u OCF represens only he porion of operaing cash flows available for remiance ha can be legally remie o he paren firm. = SτD ( i ) S RF S CL = = SτI ( i ) SLP ( i ) he marginal corporae ax rae, τ, is he larger of he paren s or foreign subsiiary s. 8-28 Copyrigh 27 by he McGraw-Hill Companies, Inc. All righs reserve. Capial Bugeing from he Paren Firm s Perspecive APV = = SV ( K ) u SOCF ( τ) ( K ) S C u S RF represens he value of accumulae resrice funs (in he amoun of RF ) ha are free up by he projec. = SτD ( i ) S RF S CL = = SτI ( i ) SLP ( i ) Denoes he presen value (in he paren s currency) of any concessionary loans, CL, an loan paymens, LP, iscoune a i. 8-29 Copyrigh 27 by he McGraw-Hill Companies, Inc. All righs reserve.
Risk Ajusmen in he Capial Bugeing Process l Clearly risk an reurn are correlae. l Poliical risk may exis along sie of business risk, necessiaing an ajusmen in he iscoun rae. 8-3 Copyrigh 27 by he McGraw-Hill Companies, Inc. All righs reserve. Sensiiviy Analysis l In he APV moel, each cash flow has a probabiliy isribuion associae wih i. l Hence, he realize value may be ifferen from wha was expece. l In sensiiviy analysis, ifferen esimaes are use for expece inflaion raes, cos an pricing esimaes, an oher inpus for he APV o give he manager a more complee picure of he planne capial invesmen. 8-3 Copyrigh 27 by he McGraw-Hill Companies, Inc. All righs reserve. Real Opions l he applicaion of opions pricing heory o he evaluaion of invesmen opions in real projecs is known as real opions. n A iming opion is an opion on when o make he invesmen. n A growh opion is an opion o increase he scale of he invesmen. n A suspension opion is an opion o emporarily cease proucion. n An abanonmen opion is an opion o qui he invesmen early. 8-32 Copyrigh 27 by he McGraw-Hill Companies, Inc. All righs reserve.
En Chaper Seveneen 8-33 Copyrigh 27 by he McGraw-Hill Companies, Inc. All righs reserve. 2