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CH18 - CHAPTER 18 INTERNATIONAL CAPITAL BUDGETING DECISIONS...

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CHAPTER 18 INTERNATIONAL CAPITAL BUDGETING DECISIONS CHAPTER OUTLINE I. The Foreign Investment Decision Process a) Search for foreign investment b) Political climate c) Company's overall strategy (1) Company goal (2) Company policy (3) Company resources d) Cash flow analysis (1) Demand forecast (2) Duties and taxes (3) Foreign exchange rates and restrictions (4) Project vs. parent cash flows (5) Capital budgeting and transfer pricing e) The cost of capital f) Economic evaluation g) Selection h) Risk analysis i) Implementation, control, and post audits (1) Implementation (2) Control (3) Post audit j) Real option analysis II. Portfolio Theory III. Capital Budgeting Theory and Practice a) Project evaluation techniques b) Company goals IV. Political Risk Management a) Nature of political risks b) Types of political risks c) Operational restrictions d) Expropriation e) Forecasting political risks f) Delphi technique g) Grand tour h) Old hand i) Quantitative analysis j) Multiple methods k) Responses to political risks l) Defensive measures before investment 150
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m) Defensive measures after investment V. Summary 151
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CHAPTER OBJECTIVE Chapter 18 identifies additional considerations in multinational capital budgeting. More specifically, this chapter focuses on three interrelated aspects of multinational capital budgeting that are infrequently considered in domestic investment analysis. These three additional considerations are: (1) the entire process of planning capital expenditures in foreign countries beyond one year, (2) how international diversification can reduce the overall riskiness of a company, and (3) a comparative analysis of capital budgeting theory with capital budgeting practice. In addition, this chapter discusses the nature of political risk, defines the types of political risks and methods of forecasting such risks, and presents some possible corporate responses. KEY TERMS AND CONCEPTS Cost of capital is the minimum rate of return that a project must yield in order to be accepted by a company. Discounted cash flow approaches are the net present-value and internal-rate-of-return methods. Net present value of a project is the present value of its expected cash inflows minus the present value of its expected cash outflows. Internal rate of return is the discount rate that equates the present value of the net cash flows to the present value of the net cash investment, or the rate that provides a zero net present value. Hurdle rate may be based on the cost of capital, the opportunity cost, or some other arbitrary standard; a project’s expected rate of return must exceed this rate in order to be accepted. Risk-adjusted discount rate is a rate that consists of the riskless rate of return plus a risk premium. Certainty equivalent approach is a method used to adjust for project risk in the numerator of the net present value formula.
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