Foreign Complexities

David Eiteman, Arthur Stonehill and Michael Moffett have identified the following complexities regarding capital budgeting decisions of foreign projects. They are;

• Parent cash flow must be distinguished from project cash flows. Each of these two types of flows contributes to a different view of value.
• Parent cash flow often depends on the form of financing. Thus, cash flows cannot be clearly separated from financing decisions, as is done in domestic capital budgeting.
• Additional cash flows generated by a new investment in one foreign affiliate may be in par or in whole taken away from another affiliate, with the net result that the project is favorable from a single affiliate‘s point of view but contribute nothing to world wide cash flows.
• Remittance of fund to the parent must be explicitly recognized because of differing tax systems, legal and political constraints on the movement of funds, local business norms, and difference in the way financial markets and institutions functions.
• Cash flows from affiliates to the parent can be generated by an array of nonfinancial payments, including payments of license fees and payments for imports from the parent.
• Differing rate of national inflation must be anticipated because of their potential to cause changes in competitive position, and thus change in cash flows over a period of time.
• The possibility of unanticipated foreign exchange rate changes must be kept in mind because of possible direct effects on the value to the parent of local cash flows, as well as indirect effects on the competitive position of the foreign affiliate.
• Use of host-government subsidized loan complicates both capital structure and the ability to determine an appropriate weighted-average cost of capital for discounting purposes.
• Political risk should be evaluated because political events can drastically minimize the availability or value of expected cash flows.
• Terminal value is quite difficult to estimate because potential purchasers from the host, parent, or third countries, of from the public or sector, may have widely divergent perspectives on the value to them of acquiring the project.