International Financial ManagementBekaert 2eSolutionsCh15.docx

1、International Financial Management Bekaert 2e Solutions Ch15Chapter 15International Capital Budgetingquestions1. Can an investment project of a foreign subsidiary that has a positive net present value when evaluated as a stand-alone firm ever be rejected by the parent corporation? Assume that the pa

2、rent accepts all projects with positive adjusted net present values.Answer: Yes, we know that countries impose withholding taxes on the dividends that are repatriated from subsidiaries to parent corporations. These taxes lower the value of the project to the parent. The parent must also be aware of

3、the possibility of future problems accessing the foreign exchange market from the subsidiarys country. In general, political risk could be different for a subsidiary of a multinational corporation versus a local stand-alone firm.2. How do licensing agreements, royalties, and overhead allocation fees

4、 affect the value of a foreign project?Answer: Licensing agreements, royalties, and overhead allocation fees are true costs to the subsidiary or to the stand-alone firm that would be operating in the foreign country producing and selling the products of the multinational corporation. Thus, licensing

5、 agreements, royalties, and overhead allocation fees reduce the income in the foreign country. Nevertheless, these cash flows provide profit to the parent corporation. Licensing agreements and royalties provide pure profit to the parent as no costs are incurred, and overhead fees provide net profit

6、as they cover costs incurred by the parent. Thus, these cash flows are quite valuable to the parent.3. Why does an adjusted net present value analysis treat the present value of financial side effects as a separate item? Isnt interest expense a legitimate cost of doing business?Answer: The adjusted

7、net present value approach to capital budgeting starts by valuing the free cash flows to the all-equity cash firm. It then adds other sources of value associated with how the firm is financed. As in the weighted average cost of capital (WACC) approach in Chapter 16, the numerator cash flows are the

8、free cash flows to the all equity firm. In contrast to WACC analysis, which discounts these cash flows with a discount rate that is a weighted average of the after-tax required return on the debt and the rate of return on the levered equity, the ANPV analysis uses the rate of return on the unlevered

9、 assets to get the all-equity value. Students sometimes think that the deductibility of interest as a business expense is therefore missing, and they want to reduce the all-equity free cash flows by the after-tax interest payments. This misses the fact that the value of the interest tax shields is b

10、eing added as a separate source of value in ANPV, whereas it is included in WACC. Also, it misses the fact that when the equity holders lever the firm, they get the principal on the debt up front and dont have to put as much equity into the firm for its investments. The present value of the future c

11、ash outflows for interest payments and repayment of principal equal the initial value of the principal, in which case it is only the tax shield that needs to be valued. ANPV does this separately.4. What is meant by the net present value of the financial side effects of a project?Answer: Generally, t

12、hese effects arise from the costs of issuing securities, the taxes or tax deductions associated with the type of financing instrument used (including the tax deductibility of the interest paid on the debt), the costs of financial distress, and the availability of subsidized financing from government

13、s.5. Why is it costly to issue securities?Answer: The investment bankers who handle the issuing of securities either to the public or to private investors are financial intermediaries, and they must be compensated for the use of their scarce resources. This compensation includes a monetary fee, but

14、it also often includes an underwriting discount, or spread. The underwriting discount between what the corporation receives from issuing the securities and what the public pays for the securities is often a large part of the compensation of the investment bank that underwrites the issue.6. What is a

15、n interest tax shield? How do you calculate its value?Answer: The interest tax shield on a debt is the value of the ability to deduct interest as a business expense. Therefore, at a point in time it is equal to the corporate tax rate times the amount of interest,. This tax deduction is discounted at

16、 the stated debt rate, which is the market debt rate associated with that debt. Thus, the discounted present value of a perpetual interest tax shield is 7. What is an interest subsidy? How do you calculate its value?Answer: Interest subsidies arise when governments are willing to lend to corporation

17、s at below market interest rates. Such subsidies add value to a project. The appropriate discount rate for an interest subsidy is the markets required rate of return on the debt of the corporation because the corporation is just as likely to default on a subsidized loan from the government as it is

18、on a normal loan at market interest rates. Suppose that the government lets a corporation borrow a principal of D for one period at a subsidized interest rate of rS rD, which is the markets required rate of return on the corporations debt. The corporation borrows D in the first period, and it repays

19、 (1 + rS)D in the second period. Because the actual interest payment is deductible, the corporation also gets a tax deduction of rS D in the second period. The present value of the cash flows of the subsidized debt discounted at the markets required rate of return on the corporations debt is therefo

20、reThe value of a loan at a subsidized, below-market, interest rate has two components: the present value of the interest subsidy, which is the difference between the interest paid on a market loan and the interest on the subsidized loan, plus the present value of the actual interest tax shield. In b

21、oth cases, the present value is taken at the markets required rate of return on the debt.8. What are growth options? Provide an example of one in an international context.Answer: A growth option arises when a firm undertakes a project and obtains an option to do another project in the future. The op

22、tion to do the second project adds value to the first project. A growth option might include a firms ability to sell a new product that is successful in the domestic market in the international marketplace. Growth options are specific examples of real options that also include the ability of a firm

23、to shut down a plant or a mine until operating conditions improve or to delay an important operating decision until more information can be gathered. Real options are valuable.9. What is the difference between EBIT and NOPLAT?Answer: The acronym EBIT is earnings before interest and taxes. It represe

24、nts the before-tax operating profit of the firm. The acronym NOPLAT is net operating profit less adjusted taxes. It is found by taking the taxes out of EBIT that would be paid by the all-equity firm. It is therefore the after-tax operating profit of the all-equity firm.10. Why is it important to und

25、erstand and manage net working capital?Answer: The stock of net working capital is the amount of inventory, cash, and accounts receivable minus accounts payable that the firm must have on hand to run its business. If the business can be run with a lower net working capital, this amount of assets cou

26、ld be given to investors. Conversely, increases in net working capital use after-tax profits that the firm could otherwise use to finance capital expenditures or pay to investors. As such, changes in net working capital are investments that the firm makes in its future profitability.11. What does CA

27、PX mean, and why is it a firms engine of growth?Answer: CAPX is an acronym that is short for capital expenditures. These are investments that the firm is making in physical plant and equipment that will produce output in the future. Consequently, if the firm wants to grow, it will have to do CAPX, a

28、nd in this sense, CAPX is the firms engine of growth.12. Why is it sometimes assumed that CAPX equals depreciation in the later stages of a project? How does expected inflation affect this assumption?Answer: As a project matures, there are no more planned investments in which case the scale of the p

29、roject is fixed. But, the physical plant and equipment have an economic lifetime and must be replaced. If accounting depreciation matches economic depreciation, setting CAPX equal to depreciation is appropriate. You should be aware that accounting depreciation often fails to match economic depreciat

30、ion because of inflation. The higher the rate of inflation, the more severe this problem is unless the accounting depreciation is indexed to inflation in some way. Because CAPX will be spent on real plant and equipment, the nominal amount of expenditures may be somewhat greater than the amount the a

31、ccounts are allowed to deduct for the book value of depreciation.13. What is the terminal value of a project? How is it calculated?Answer: The terminal value of a project is the present discounted value of all future free cash flows in the years beyond an explicit forecasting horizon. If we generate

32、 explicit forecasts of free cash flows for the next 10 years, the terminal value is the present discounted value of free cash flows in years 11 to infinity. One typically assumes that future free cash flows will grow at the rate g, and the discount rate for these perpetual cash flows is r. The starting value in year 11 is (1+ g) higher than the expected free cash flows in year 10. From the perpetuity formula for a growing cash flow, we know thatAfter calculating the terminal value in year 10, that quantity must then be discounted to year 0 by mul