International-Financial-Management---Bekaert-2e---Solutions---Ch15.doc
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15
Chapter15:
InternationalCapitalBudgeting
Chapter 15
InternationalCapitalBudgeting
QUESTIONS
1.Cananinvestmentprojectofaforeignsubsidiarythathasapositivenetpresentvaluewhenevaluatedasastand-alonefirmeverberejectedbytheparentcorporation?
Assumethattheparentacceptsallprojectswithpositiveadjustednetpresentvalues.
Answer:
Yes,weknowthatcountriesimposewithholdingtaxesonthedividendsthatarerepatriatedfromsubsidiariestoparentcorporations.Thesetaxeslowerthevalueoftheprojecttotheparent.Theparentmustalsobeawareofthepossibilityoffutureproblemsaccessingtheforeignexchangemarketfromthesubsidiary’scountry.Ingeneral,politicalriskcouldbedifferentforasubsidiaryofamultinationalcorporationversusalocalstand-alonefirm.
2.Howdolicensingagreements,royalties,andoverheadallocationfeesaffectthevalueofaforeignproject?
Answer:
Licensingagreements,royalties,andoverheadallocationfeesaretruecoststothesubsidiaryortothestand-alonefirmthatwouldbeoperatingintheforeigncountryproducingandsellingtheproductsofthemultinationalcorporation.Thus,licensingagreements,royalties,andoverheadallocationfeesreducetheincomeintheforeigncountry.Nevertheless,thesecashflowsprovideprofittotheparentcorporation.Licensingagreementsandroyaltiesprovidepureprofittotheparentasnocostsareincurred,andoverheadfeesprovidenetprofitastheycovercostsincurredbytheparent.Thus,thesecashflowsarequitevaluabletotheparent.
3.Whydoesanadjustednetpresentvalueanalysistreatthepresentvalueoffinancialsideeffectsasaseparateitem?
Isn’tinterestexpensealegitimatecostofdoingbusiness?
Answer:
Theadjustednetpresentvalueapproachtocapitalbudgetingstartsbyvaluingthefreecashflowstotheall-equitycashfirm.Itthenaddsothersourcesofvalueassociatedwithhowthefirmisfinanced.Asintheweightedaveragecostofcapital(WACC)approachinChapter16,thenumeratorcashflowsarethefreecashflowstotheallequityfirm.IncontrasttoWACCanalysis,whichdiscountsthesecashflowswithadiscountratethatisaweightedaverageoftheafter-taxrequiredreturnonthedebtandtherateofreturnontheleveredequity,theANPVanalysisusestherateofreturnontheunleveredassetstogettheall-equityvalue.Studentssometimesthinkthatthedeductibilityofinterestasabusinessexpenseisthereforemissing,andtheywanttoreducetheall-equityfreecashflowsbytheafter-taxinterestpayments.ThismissesthefactthatthevalueoftheinteresttaxshieldsisbeingaddedasaseparatesourceofvalueinANPV,whereasitisincludedinWACC.Also,itmissesthefactthatwhentheequityholdersleverthefirm,theygettheprincipalonthedebtupfrontanddon’thavetoputasmuchequityintothefirmforitsinvestments.Thepresentvalueofthefuturecashoutflowsforinterestpaymentsandrepaymentofprincipalequaltheinitialvalueoftheprincipal,inwhichcaseitisonlythetaxshieldthatneedstobevalued.ANPVdoesthisseparately.
4.Whatismeantbythenetpresentvalueofthefinancialsideeffectsofaproject?
Answer:
Generally,theseeffectsarisefromthecostsofissuingsecurities,thetaxesortaxdeductionsassociatedwiththetypeoffinancinginstrumentused(includingthetaxdeductibilityoftheinterestpaidonthedebt),thecostsoffinancialdistress,andtheavailabilityofsubsidizedfinancingfromgovernments.
5.Whyisitcostlytoissuesecurities?
Answer:
Theinvestmentbankerswhohandletheissuingofsecuritieseithertothepublicortoprivateinvestorsarefinancialintermediaries,andtheymustbecompensatedfortheuseoftheirscarceresources.Thiscompensationincludesamonetaryfee,butitalsooftenincludesanunderwritingdiscount,orspread.Theunderwritingdiscountbetweenwhatthecorporationreceivesfromissuingthesecuritiesandwhatthepublicpaysforthesecuritiesisoftenalargepartofthecompensationoftheinvestmentbankthatunderwritestheissue.
6.Whatisaninteresttaxshield?
Howdoyoucalculateitsvalue?
Answer:
Theinteresttaxshieldonadebtisthevalueoftheabilitytodeductinterestasabusinessexpense.Therefore,atapointintimeitisequaltothecorporatetaxratetimestheamountofinterest,.Thistaxdeductionisdiscountedatthestateddebtrate,whichisthemarketdebtrateassociatedwiththatdebt.Thus,thediscountedpresentvalueofaperpetualinteresttaxshieldis
7.Whatisaninterestsubsidy?
Howdoyoucalculateitsvalue?
Answer:
Interestsubsidiesarisewhengovernmentsarewillingtolendtocorporationsatbelowmarketinterestrates.Suchsubsidiesaddvaluetoaproject.Theappropriatediscountrateforaninterestsubsi