Discuss the following two questions:
1. A foreign project that is profitable when valued on its own will always be profitable from the parent firm's standpoint. True or false? Explain.
2. What factors should be considered in deciding whether the cost of capital for a foreign affiliate should be higher, lower, or the same as the cost of capital for a comparable domestic operation?
1. It is false that a foreign project that is profitable when valued on its own will always be profitable from the parent firm's standpoint. This is mainly because the cash flows from the project can in most cases diverge from the incremental cash flows that are accruing to the parent firm. The additional cash flows from a new foreign project may in whole or part take away from another subsidiary of a company and therefore though on its own it is proving cash flows it adds no value to the overall organizational value (Madura, 2008, p. 387).
As noted, the main reason why foreign projects may not be deemed profitable from the parent company's viewpoint is due to a divergence in the project cash flows from the additional cash flow accruing to the parent company. Reasons for this divergence may include fees and royalties, tax regulations, transfer pricing or exchange controls in these foreign countries. For instance cash flows remitted to the ...
This solution discusses the finance details of a foreign project.