Unformatted text preview: tion of profit, the result is that the parent corporation
cannot use cash flows blocked in the foreign country to pay
dividends to its shareholders or to invest elsewhere in the
In addition to the complexities of the cash flow analysis, the
cost of capital may be different for a foreign project than
for an equivalent domestic project, because foreign projects
may be more or less risky.
A higher risk could arise from two primary sources—(1)
exchange rate risk and (2) political risk.
A lower risk might result from international diversification.
Exchange rate risk relates to the value of the basic cash flows in
the parent company’s home currency.
24 Multinational Capital Budgeting However the two risks can often hedge each other. Suppose
an investor in the US buys shares in a British company.
There will be a risk that the value of the investment in dollar
terms may decline if the pound falls against the dollar.
However if the pound depreciates, the share price is likely
to rise as the value in pounds of its dollar denominated sales
The end result is that the two types of exchange rate risk
neatly hedge each other.
Political risk refers to potential actions by a host government that
would reduce the value of a company’s investment.
25 Multinational Capital Budgeting It includes at one extreme the expropriation (the official seizure
by a government of private property) without compensation of
the subsidiary’s assets,
but it also includes less drastic actions that reduce the value of
the parent firm’s investment in the foreign subsidiary, including
higher taxes, tighter repatriation or currency controls, and
restrictions on prices charged.
The risk of expropriation is small in traditionally friendly and
stable countries such as Great Britain or Switzerland.
However, in Latin America, Africa, the Far East, and Eastern
Europe, the risk may be substantial.
View Full Document
This note was uploaded on 02/11/2014 for the course MANA 2028 taught by Professor Sisterennis during the Winter '12 term at Marquette.
- Winter '12