Chapter_17

# Chapter_17 - Chapter Outline Review of Domestic Capital...

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Chapter Outline Review of Domestic Capital Budgeting The Adjusted Present Value Model Capital Budgeting from the Parent Firm’s Perspective Risk Adjustment in the Capital Budgeting Process Sensitivity Analysis Real Options

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Review of Domestic Capital Budgeting 1. Identify the SIZE and TIMING of all relevant cash flows on a time line. 2. Identify the RISKINESS of the cash flows to determine the appropriate discount rate. 3 . Find NPV by discounting the cash flows at the appropriate discount rate. 4. Compare the value of competing cash flow streams at the same point in time.
One recipe for international decision makers: 1. Estimate future cash flows in foreign currency. 2. Convert to U.S. dollars at the predicted exchange rate. 3. Calculate NPV using the U.S. cost of capital. International Capital Budgeting

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International Capital Budgeting Example Is this a good investment from the perspective of the U.S. shareholders? π = 3% i \$ = 15% π \$ = 6% – 600€ 0 200€ 1 500€ 2 300€ 3 \$.55265 S 0 (\$/€) =
International Capital Budgeting: Example – 600€ 200€ 500€ 300€ 0 1 year 2 years 3 years \$331.60 CF 0 = (€600)× S 0 (\$/€) =(€600)× = \$331.60 \$.55265

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International Capital Budgeting: Example – 600€ 200€ 500€ 300€ 0 1 year 2 years 3 years CF 1 = (€200)× E [ S 1 (\$/€)] = E [ S 1 (\$/€)] can be found by appealing to the interest rate differential: \$331.60 \$113.70 1.03 1.06 E [ S (1)] = × S 0 (\$/€) 1.03 1.06 = × \$.55265 = \$.5687/€ so CF 1 = (€200)×(\$.5687/€) = \$113.7
International Capital Budgeting: Example – 600€ 200€ 500€ 300€ 0 1 year 2 years 3 years \$331.60 \$113.70 \$292.60 Similarly, CF 2 = × S 0 (\$/€) × (€500) = \$292.6 1.03 1.06 1.03 1.06 ×

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International Capital Budgeting: Example – 600€ 200€ 500€ 300€ 0 1 year 2 years 3 years \$331.60 \$113.70 \$292.60 \$180.70 30 . 107 \$ ) 15 . 1 ( 70 . 180 \$ ) 15 . 1 ( 60 . 292 \$ ) 15 . 1 ( 70 . 113 \$ 60 . 336 \$ 3 2 = + + + - = NPV CF 3 = × S 0 (\$/€) × (€300) = \$180.7 (1.03) 3 (1.06) 3
Another recipe for international decision makers: 1. Estimate future cash flows in foreign currency. 2. Estimate the foreign currency discount rate. 3. Calculate the foreign currency NPV using the foreign cost of capital. 4. Translate the foreign currency NPV into dollars using the spot exchange rate International Capital Budgeting

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Foreign Currency Cost of Capital Method Let’s find i and use that on the euro cash flows to find the NPV in euros.
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Chapter_17 - Chapter Outline Review of Domestic Capital...

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