FINANCIAL ASPECTS OF THE INVESTMENT DECISION
FINANCIAL ASPECTS OF THE
INVESTMENT DECISION
An MNE considering foreign investment has many financing options available. The parent company must consider the mix of debt and equity that it will use and which capital market around the world will be tapped to supply the funds. There are at least two basic reasons why the debt-equity ratio for a foreign subsidiary may differ from that of the parent. First, the attitude toward the debt-equity ratio in the host country may differ from that in the parent country. Firms in Japan and Germany, for example, tend to be more highly leveraged than their U.S. counterparts, which means that they rely much more on debt than on equity capital.
Second, different tax rates, dividend remission policies, and exchange controls may cause a firm to rely more on debt in some situations and on equity on others. The debt-equity ratio of the MNE will be a weighted average of the debt-equity ratios of all entities in the corporate structure. Japanese, German, and Swiss firms have traditionally relied on debt financing because of the relatively better availability on debt rather than equity financing and because of low interest rates. A rise in interest rates and improvement in equity markets in recent years have caused firms in those countries to consider shifting the mix of debt and equity financing.
Discounted cash flows often are used to compare and evaluate investment projects. Several aspects of capital budgeting unique to foreign project assessment follow:
1. There is a need to distinguish between total cash flows of the project and cash flows remitted to the parent company.
2. Because of differing tax systems, restrictions on financial flows, local norms, and differences in financial markets and institutions, the financing and remittance of funds to the parent firm must be recognized.
3. Different rates of national inflation can be important in changing competitive positions (and thereby cash flows) over time.
4. Foreign-exchange rate changes may alter the competitive position of a foreign affiliate.
5. Political factors can drastically reduce the value of a foreign investment.
6. The final sale value is difficult to estimate because of possible divergent market values of a project to potential purchasers from the host, parent, or third countries.35
The parent firm must compare the net present value or internal rate of return of a project with that of other parent projects. At the same time, it should compare the project with others available in the host country.
Management must view cash flows from two perspectives: (1) the total flows available to the local operations and (2) the cash available to the parent. The outflows to the parent are important to consider in light of the original investment made, especially if the investment was with parent funds. FinaBf. the firm must analyze foreign political and exchange risks. The best approach is for the firm to adjust forecasted cash outflows to different estimates representing different levels of risk.
INVESTMENT DECISION
An MNE considering foreign investment has many financing options available. The parent company must consider the mix of debt and equity that it will use and which capital market around the world will be tapped to supply the funds. There are at least two basic reasons why the debt-equity ratio for a foreign subsidiary may differ from that of the parent. First, the attitude toward the debt-equity ratio in the host country may differ from that in the parent country. Firms in Japan and Germany, for example, tend to be more highly leveraged than their U.S. counterparts, which means that they rely much more on debt than on equity capital.
Second, different tax rates, dividend remission policies, and exchange controls may cause a firm to rely more on debt in some situations and on equity on others. The debt-equity ratio of the MNE will be a weighted average of the debt-equity ratios of all entities in the corporate structure. Japanese, German, and Swiss firms have traditionally relied on debt financing because of the relatively better availability on debt rather than equity financing and because of low interest rates. A rise in interest rates and improvement in equity markets in recent years have caused firms in those countries to consider shifting the mix of debt and equity financing.
Discounted cash flows often are used to compare and evaluate investment projects. Several aspects of capital budgeting unique to foreign project assessment follow:
1. There is a need to distinguish between total cash flows of the project and cash flows remitted to the parent company.
2. Because of differing tax systems, restrictions on financial flows, local norms, and differences in financial markets and institutions, the financing and remittance of funds to the parent firm must be recognized.
3. Different rates of national inflation can be important in changing competitive positions (and thereby cash flows) over time.
4. Foreign-exchange rate changes may alter the competitive position of a foreign affiliate.
5. Political factors can drastically reduce the value of a foreign investment.
6. The final sale value is difficult to estimate because of possible divergent market values of a project to potential purchasers from the host, parent, or third countries.35
The parent firm must compare the net present value or internal rate of return of a project with that of other parent projects. At the same time, it should compare the project with others available in the host country.
Management must view cash flows from two perspectives: (1) the total flows available to the local operations and (2) the cash available to the parent. The outflows to the parent are important to consider in light of the original investment made, especially if the investment was with parent funds. FinaBf. the firm must analyze foreign political and exchange risks. The best approach is for the firm to adjust forecasted cash outflows to different estimates representing different levels of risk.
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