INVESTMENT PROPOSAL EVALUATION
INVESTMENT PROPOSAL EVALUATION
Thus far we have examined comparative opportunities on a very broad basis. At some point it is necessary for firms to do a much more detailed analysis of specific projects and proposals in order to make allocation decisions. Firms use a variety of financial criteria to evaluate foreign investments, internal rate of return and accounting rate of return being the measurements most frequently used.40
Measurement Problems
The derivation of meaningful rate-of-return figures is no easy task when foreign operations are concerned. Profit figures from individual operations may obscure the real impact those operations have on overall company activities. For example, if a U.S. company were to establish an assembly operation in Australia, this assembly operation could either increase or decrease exports from the United States. Management would have to make assumptions about the changed profits in the United States and elsewhere as a result of the Australian project. Or perhaps by building a plant in Brazil to supply components to Volkswagen of Brazil, the investor increases the possibility of selling to Volkswagen in other countries.
The preceding discussion assumes that, although overall company returns are difficult to calculate, those for the operating subsidiary are fairly
easily ascertained, but this is not the case. A substantial portion of the sales and purchases of foreign subsidiaries may be with units of the same parent company. The prices charged on these transactions will affect the relative profitability of one unit vis-a-vis another. Furthermore, the base on which to estimate the net value of the foreign investment may not be realistically stated, particularly if part of the net value is based on exported capital equipment that is both obsolete at home and useless except where being shipped. By stating a high value, the company may be permitted to repatriate a larger portion of its earnings.
Nortcomparative Decision Making
Because of the limited resources firms have at their disposal, it might seem mat companies maintain a storehouse of foreign investment proposals that
maY be ranked on the basis of some predetermined criteria. If this were so,
management could simply start allocating resources to the top-ranked proposal and continue down the list until no further investments were possible. This is seldom the case, however. About three quarters of final investment proposals are evaluated separately, and a decision is made on what is commonly known as a go-no-go decision.41 This decision is usually made on the basis that the project meets some minimum-threshold criteria. Of course, before this there is a good deal of weeding out of possible projects at various scanning and decision points along the way.
One of the major factors restricting firms from comparing investment opportunities is cost. Clearly, most firms cannot afford to conduct very many investigations simultaneously. Another factor inhibiting comparison of investment opportunities is that feasibility studies are apt to be in various stages of completion at a given time. Assume that the investigation process has been finished for a possible project in Australia but that ongoing research is being conducted for New Zealand, Japan, and Indonesia. Can the company afford to wait until the results from all the surveys are completed? The answer is probably not. The time interval between completions probably would invalidate much of the earlier results, requiring an updating, added expense, and further delays.
There are other time-inhibiting problems as well. Frequently, governmental regulations may require a decision within a given period of time. Another external limitation may be imposed by other companies that have made partnership proposals. If no answer is forthcoming in a short period of time, a proposal may be made to a different potential partner.
Finally, few companies can afford to let resources lie idle or to be employed for a low rate of return during a waiting period. They must answer to both stockholders and employees. This applies not only to financial resources but also to such resources as technical competence, since the lead time over competitors is reduced when a company holds off a decision.
Reinvestment Decisions
Most of the net value of foreign investment has come from the reinvestment of earnings abroad rather than from new international capital transfers. The decisions to replace depreciated assets or to add to the existing stock of capital from retained earnings in a foreign country are somewhat different from original investment decisions. Once committed to a given locale, a firm may find that there is no option to move a substantial portion of the earnings elsewhere because to do so would endanger the continued successful operation of the given foreign facility. For example, the failure to expand might result in a falling market share and a higher unit cost than that of competitors.
Aside from competitive factors, a company may need several years of almost total reinvestment as well as allocation of new funds to one area in order to meet its objectives. Over a period of time, the earnings may be used to expand the product line further, integrate production, and expand the market served from present output. A further factor for treating reinvestment decisions differently is that once there are experienced personnel within a given country, they may be the best judges of what is needed for their countries; therefore, certain investment decisions may be delegated to them.
Thus far we have examined comparative opportunities on a very broad basis. At some point it is necessary for firms to do a much more detailed analysis of specific projects and proposals in order to make allocation decisions. Firms use a variety of financial criteria to evaluate foreign investments, internal rate of return and accounting rate of return being the measurements most frequently used.40
Measurement Problems
The derivation of meaningful rate-of-return figures is no easy task when foreign operations are concerned. Profit figures from individual operations may obscure the real impact those operations have on overall company activities. For example, if a U.S. company were to establish an assembly operation in Australia, this assembly operation could either increase or decrease exports from the United States. Management would have to make assumptions about the changed profits in the United States and elsewhere as a result of the Australian project. Or perhaps by building a plant in Brazil to supply components to Volkswagen of Brazil, the investor increases the possibility of selling to Volkswagen in other countries.
The preceding discussion assumes that, although overall company returns are difficult to calculate, those for the operating subsidiary are fairly
easily ascertained, but this is not the case. A substantial portion of the sales and purchases of foreign subsidiaries may be with units of the same parent company. The prices charged on these transactions will affect the relative profitability of one unit vis-a-vis another. Furthermore, the base on which to estimate the net value of the foreign investment may not be realistically stated, particularly if part of the net value is based on exported capital equipment that is both obsolete at home and useless except where being shipped. By stating a high value, the company may be permitted to repatriate a larger portion of its earnings.
Nortcomparative Decision Making
Because of the limited resources firms have at their disposal, it might seem mat companies maintain a storehouse of foreign investment proposals that
maY be ranked on the basis of some predetermined criteria. If this were so,
management could simply start allocating resources to the top-ranked proposal and continue down the list until no further investments were possible. This is seldom the case, however. About three quarters of final investment proposals are evaluated separately, and a decision is made on what is commonly known as a go-no-go decision.41 This decision is usually made on the basis that the project meets some minimum-threshold criteria. Of course, before this there is a good deal of weeding out of possible projects at various scanning and decision points along the way.
One of the major factors restricting firms from comparing investment opportunities is cost. Clearly, most firms cannot afford to conduct very many investigations simultaneously. Another factor inhibiting comparison of investment opportunities is that feasibility studies are apt to be in various stages of completion at a given time. Assume that the investigation process has been finished for a possible project in Australia but that ongoing research is being conducted for New Zealand, Japan, and Indonesia. Can the company afford to wait until the results from all the surveys are completed? The answer is probably not. The time interval between completions probably would invalidate much of the earlier results, requiring an updating, added expense, and further delays.
There are other time-inhibiting problems as well. Frequently, governmental regulations may require a decision within a given period of time. Another external limitation may be imposed by other companies that have made partnership proposals. If no answer is forthcoming in a short period of time, a proposal may be made to a different potential partner.
Finally, few companies can afford to let resources lie idle or to be employed for a low rate of return during a waiting period. They must answer to both stockholders and employees. This applies not only to financial resources but also to such resources as technical competence, since the lead time over competitors is reduced when a company holds off a decision.
Reinvestment Decisions
Most of the net value of foreign investment has come from the reinvestment of earnings abroad rather than from new international capital transfers. The decisions to replace depreciated assets or to add to the existing stock of capital from retained earnings in a foreign country are somewhat different from original investment decisions. Once committed to a given locale, a firm may find that there is no option to move a substantial portion of the earnings elsewhere because to do so would endanger the continued successful operation of the given foreign facility. For example, the failure to expand might result in a falling market share and a higher unit cost than that of competitors.
Aside from competitive factors, a company may need several years of almost total reinvestment as well as allocation of new funds to one area in order to meet its objectives. Over a period of time, the earnings may be used to expand the product line further, integrate production, and expand the market served from present output. A further factor for treating reinvestment decisions differently is that once there are experienced personnel within a given country, they may be the best judges of what is needed for their countries; therefore, certain investment decisions may be delegated to them.
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