Chapter 18: International Capital Budgeting

Which formulas express the time t cash flow of a firm CFt?

(Rt − OCt − Dt − It)(1 − τ) + Dt + It(1 − τ) NIt + Dt + It(1 − τ)

Match the terms of the net present value equation with their definitions.

CFt: Expected after-tax cash flow for year t TVT: Expected after-tax terminal value C0: Initial investment at inception K: Weighted-average cost of capital T: Economic life of the capital project in years

Sensitivity analysis allows the financial manager a means to analyze which of the following?

Economic exposure Business risk Political risk Exchange rate uncertainty

True or false: Depreciation is a non-cash expense, so it must be subtracted from net income to adjust to cash flow.

False

A main implication of ____ and _____'s theory is that the value of a levered firm is greater than an equivalent unlevered firm earning the same NOI because the levered firm also has tax savings from the tax deductibility of interest payments to debtholders that do not go to the government.

Modigliani Miller

Match the terms of the adjusted present value equation with their definitions.

OCFt: Expected operating flow for year t Dt: Expected depreciation for year t It: iDebt Ku: The all-equity cost of capital i: The levered firm's borrowing rate

Which statements are true about the payback method?

The shorter the payback period the more acceptable is the project. The payback method determines the period of time required for the cumulative cash inflows to "pay back" the initial cash outlay.

Match the situation to the type of real option.

Timing option: When to make an investment Growth option: Whether to increase the scale of an investment Suspension option: Whether to temporarily cease production Abandonment option: Whether to quit the investment early

What did Modigliani and Miller find as the relationship between the market value of a levered firm Vl versus the market value of an equivalent unlevered firm Vu involving the tax rate τ.

Vl = Vu + τ Debt

Repatriation cash flows that will exist regardless of how the firm is financed should be discounted at the ______ rate.

all-equity

The cost of equity for a firm financed only with equity is the ____-____ cost of equity

all-equity

The method of risk adjustment that extracts the risk premium from the expected cash flows to convert them into riskless cash flows, which are then discounted at the risk-free rate of interest, is the ___ ___ method.

certainty equivalent

A host country may offer a(n) ____ loan at a below-market rate of interest to attract economic development and investment.

concessionary

The IRR method solves for the discount rate that causes the NPV to ______.

equal zero

A ______ cost of capital means that ______ capital projects will have a positive net present value to the multinational firm.

higher; fewer lower; more

The change in the firm's total cash flows that are attributable to a capital expenditure are the _____ cash flows.

incremental

If a project has a ______ APV from the subsidiary's perspective and a ______ APV from the parent's perspective, it should be undertaken.

negative; positive positive; positive

Capital budgeting in domestic corporate finance is done with a methodology referred to as ______.

net present value analysis or discounted cash flow analysis

Modigliani and Miller's theory implies that increasing the share of debt in the capital structure will ______ a firm's net operating income.

not change

Assuming no differential in marginal tax rates, when purchasing power parity holds and all foreign cash flows can be legally repatriated to the parent firm, it does not make any difference if the capital budgeting analysis is done from the perspective of the domestic ____ firm or from the perspective of the foreign ______.

parent subsidiary

Dividing the present value of cash inflows by the initial outlay gives the ____ index.

profitability

Assuming no differential in marginal tax rates, when ___ ___ parity holds and all foreign cash flows can be legally repatriated to the parent firm, it does not make any difference if the capital budgeting analysis is done from the perspective of the parent firm or from the perspective of the foreign subsidiary.

purchasing power

Using long-run inflation estimates and ___ ____ parity can be a useful method to estimate future expected spot exchange rates.

purchasing power

The application of options pricing theory to the evaluation of investment options in projects is known as ___ options.

real

The tax benefits of borrowing made possible by a project should be taken into account ______.

regardless of how the project is financed based on the firm's optimal debt ratio

The ____-____ discount method increases or decreases the cost of capital for increases or decreases, respectively, in the systematic risk of the project relative to the firm as a whole.

risk-adjusted

When dealing with mutually exclusive projects, a conflict may arise between the profitability index and the NPV criterion because the profitability index does not take into account the ______ and the NPV method does.

scale of the investments

Different scenarios are examined by using different exchange rate estimates, inflation rate estimates, and cost and pricing estimates in the calculation of the APV to see how the results change in a(n) _____ analysis.

sensitivity

If there are difficult cash flow terms, the analyst can first analyze the capital expenditure as if these terms did not exist and then see how ______ they would have to be to _______ the sign of the APV.

small; not change large; change

Long-dated forward prices can be used to estimate the future expected ___ exchange rates.

spot

Even though depreciation is a noncash expense, it enters the incremental cash flow formula because it reduces a firm's ____ obligations.

tax

The payback method determines the amount of time until you earn back _____.

the initial cash outlay

A model such as APV in which each cash flow is considered individually is said to take a ___-___ approach to capital budgeting.

value-additivity

What is the APV capital budgeting equation?

∑t=1TOCFt(1−τ)(1+Ku)t+∑t=1TτDt(1+i)t+∑t=1TτIt(1+i)t+TVT(1+Ku)T−∑Tt=1OCFt(1-τ)(1+Ku)t+∑Tt=1τDt(1+i)t+∑Tt=1τIt(1+i)t+TVT(1+Ku)T-C0

The APV rule is to accept a project if APV ______ 0 and to reject it if APV ______ 0.

≥; <

The NPV rule is to accept a project if NPV ______ 0 and to reject it if NPV ______ 0.

≥; <

The IRR decision rule is to select the project if the IRR ______ K, but under certain circumstances a project will have multiple IRRs which causes difficulty in interpreting the simple decision rule if one or more IRRs are _____ K.

≥; less than