Chapter 7, Analyzing Foreign Investments Video Solutions, Capital Budgeting Valuation: Financial Analysis for Today's Investment Projects

Problem 1

A business development manager of a financial institution that was enthusiastically capturing Eastern European markets commented as follows: "Yes, we do make some basic calculations. But no, we do not discuss our ideas with the financial department beforehand. However, now that you mention it, the final investment proposal must indeed be sent to the financial staff. This is just a matter of rubber stamping." Comment.

Puneet Prajapati

Numerade Educator

Problem 2

"The financial modeling of foreign investments is a matter of sensitivity analysis and scenario analysis. This is not necessarily the case for domestic investments." Is this statement true? Why or why not?

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Problem 3

U.S. firms are typically less interested in the payback periods of foreign investments than, for example, German firms. Relate this to U.S. domestic depreciation practices.

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Problem 4

"Since I want to behave as a good local citizen, I am not really interested in foreign exchange rates," the financial director of ESH said in regards to a foreign investment. Others in the firm disagree with this statement. Comment on this attitude.

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Problem 5

An Australian firm, National Boomerang Beer (NBB), is preparing to enter the Litoromian market, which it considers a greenfield investment (startup). The Litoromian beer market is fragmented. Only a few firms have substantial market shares, none of which exceed 5 percent. In fact, the market is regionally divided, except for some special beers and three firms competing for a countrywide presence. Market share gains can only be acquired by accepting large price cuts.
$\bullet$ As of today, the Litos is pegged to the dollar and the beer prices are dollar related. As Litoromia will adopt the euro eventually, it will give up the peg. NBB expects a gradual changeover and depreciation. The exchange rate of the Litos vis-à-vis the Australian dollar will be AUD $1=$ LTO 2.0 on January 1, 2011 and will gradually drop to AUD $1=$ LTO 3.0 by December 31 , 2020.
$\bullet$ NBB must invest LTO 10 million by January 1, 2011, to be straight-line depreciated in 10 years. The yearly revenues will be LTO 7.5 million. Royalties and fees paid to the mother firm are 8 percent of the revenues. The yearly outlay costs for sales/marketing, production and general purposes are LTO 2.2 million, LTO 1.6 million and LTO 0.9 million, respectively. The European Union will subsidize half of the investment outlay. The Litoromian government offers NBB tax exemption during the planning period of 10 years, unless any dividend is paid before year-end 2020 .
$\bullet$ All cash flows after the investment are expected to occur at the year-end. NBB plans to reinvest depreciation funds in the business immediately. No terminal values are to be included. The cost of capital employed is 12 percent, although NBB uses a hurdle rate of 8 percent in Australia. NBB's corporate tax rate is 30 percent. Items not provided (e.g., working capital changes) are neglected.
A. Is the investment attractive from a subsidiary point of view? Provide both an ROI and an NPV calculation.
B. Is the investment attractive from a parent firm's point of view? Include an NPV calculation. Assume that NBB can earn 8 percent per year with its local excess cash flows.

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