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International environment and Capital Budgeting Decisions

3. What is capital budgeting? How is this process complicated in the international environment?

4. Discuss relevant returns as they relate to financial return perspectives. Provide examples of returns from both the project and parent perspectives.

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3. What is capital budgeting? How is this process complicated in the international environment?

4. Discuss relevant returns as they relate to financial return perspectives. Provide examples of returns from both the project and parent perspectives
Please see the attached file.

What is capital budgeting? How is this process complicated in the international environment?

The investment decisions of a firm are generally known as the capital budgeting, or capital expenditure decisions. The firm's investment decisions would generally include expansion, acquisition, modernization and replacement of the long-term assets. Sale of a division or business (divestment) is also as an investment decision.
Decisions like the change in the methods of sales distribution, or an advertisement campaign or research and development programs have long-term implications for the firm's expenditures and benefits, and therefore, they should also be evaluated as investment decisions. Several different procedures are available to analyze potential business investments. Some concepts are better than others when it comes to reliability but all provide enough information to get the general scope of the investment.

The five procedures that provide useful information are the Net present Value (NPV), the Payback Rule, the Discounted Payback, the Internal Rate of Return (IRR), and the PI). These procedures will help rank the projects from the greatest investment to the worst.

Thus capital budgeting has following characteristics:

The exchange of current funds for future benefits.
The funds are invested in long-term assets.
The future benefits will occur to the firm over a series of years.

Criteria of selection of Capital Budgeting project:

It should maximize the shareholders' wealth.
It should consider all cash flows to determine the true profitability of the project.
It should provide for an objective and unambiguous way of separating good projects from bad projects.
It should help ranking of projects according to their true profitability.
It should recognize the fact that bigger cash flows are preferable to smaller ones and early cash flows are preferable to later ones.
It should help to choose among mutually exclusive projects that project which maximizes the shareholders' wealth.
It should be a criterion, which is applicable to any conceivable investment project independent of others.

Capital Budgeting and International Environment

The basic principles applicable to an international investment decision are similar to a domestic investment decision. The incremental cash flow of the investment should be discounted at an opportunity cost of capital appropriate to the risk of the investment. The investment should be accepted if the net present value is positive.

International Risk

One factor that distinguishes the international investment decisions from the domestic investment decisions is that cash flows are earned in foreign currency. This fact should be considered while estimating the incremental cash flows. Moreover Firms must constantly assess the business environments of the countries they are already operating in as well as the ones they are considering investing in. This WACC should be adjusted by the country risk.

It involves country risk analysis, the assessment of the potential risks and rewards associated with making investments and doing business in a country. This is the subject matter of political economy—the interaction of politics and economics. Such interactions occur on a continuous basis and affect not just monetary and fiscal (tax and spending) policies but also a host of other policies that affect the business environment, such as currency or trade controls, changes in labor laws, regulatory restrictions, and requirements for additional local production.
By extension, the international economic environment is heavily dependent on the policies that individual nations pursue. Given the close linkage between a country's economic policies and the degree of exchange risk, inflation risk, and interest rate risk that multinational companies and investors face, it is vital in studying and attempting to forecast ...

Solution Summary

This discusses the international environment and capital budgeting decisions.

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