M5 - Capital Budgeting in Multinationals - Capital...

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Capital Budgeting in Multinationals How can the following affect the capital budgeting decisions of multinational companies: - exchange rate risk - political risk - tax law differences - transfer pricing - a strategic rather than a strict financial viewpoint What examples can you provide from your reading of business periodicals to support your ideas? Remember to think about both large and small firms. Capital budgeting always involves various risks. Once decisions have been made, they are generally difficult to reverse, because it would require a large amount of cash or capital in order to reverse a wrong decision. “Although the basic techniques of capital budgeting are the same for multinational companies (MNCs) as for purely domestic firms, firms that operate in several countries face risks that are unique to the international arena” (Gitman, p. 476). It is important for organizations to evaluate such risks carefully prior to implementing a capital budget, but additional considerations must be considered when dealing with multinational locations. - Exchange rate risk When exchange rates occur between two countries, it has the potential to change the projected net present value, payback period, fair value, profitability, solvency, as well as liquidity position of a company’s foreign capital project in a foreign country. Businesses mostly affected by exchange rate risks are generally involved in export and/or import of their products, supplies or services. An organization is exposed to exchange risks when their receivables and payables, whose values are directly influenced by currency exchange rates (Investopedia, n.d.). There is a particular risk, which is considered the transaction risk (Investing Answers, n.d.), which arises when an organization has a committed cash flow to be paid/received in a foreign currency. The risk involved is when an organization sells a product or service on credit and there is a delay in payment. This means that if the organization has a waiting period between sale

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