Deck 9: Advanced Capital Budgeting

Question 1

When an MNC forms a foreign subsidiary and that subsidiary is eligible for subsidies in the country where it will operate,how is the capital budgeting process for that subsidiary and its project affected?

A)Local subsidies are compensated for in NPV calculations,so no additional consideration needs to be given in the capital budgeting process.
B)Since local subsidies are subject to political risk and can be taken away as easily as they are granted,local subsidies are not considered in the capital budgeting process.
C)When local subsidies are available,the capital budgeting process is often altered to include consideration of the cash flows that will be generated by those subsidies.
D)Local subsidies are generally not available to subsidiaries that will send their profits to the MNC parent,so local subsidies are not considered in the capital budgeting process by MNCs.

Answer 1

When local subsidies are available,the capital budgeting process is often altered to include consideration of the cash flows that will be generated by those subsidies.

Question 2

Relief from multiple taxation of parent and subsidiary income may be found in tax treaties that allow:

A)subsidiaries to avoid paying taxes on income that will eventually be passed on to the parent.
B)the parent to exempt from its gross income any dividends received from foreign subsidiaries.
C)the parent to exclude from income all dividends received relative to foreign operations.
D)the parent to take a tax credit against the tax it owes for the taxes paid by the subsidiary in the country where it is located.

Answer 2

the parent to take a tax credit against the tax it owes for the taxes paid by the subsidiary in the country where it is located.

Question 3

If the NPV estimates for a project are the same for the parent and for the subsidy,then ___________ exists.

A)asymmetry
B)symmetry
C)parity
D)equality

Answer 3

parity

Question 4

When a subsidiary is restricted from remitting its profits to the parent,the parent:

A)incurs opportunity costs in the sense that it cannot use those funds for other projects.
B)incurs real costs in the nature of lost profits that could have been earned with the funds.
C)is not affected since the restricted funds will eventually be paid to the parent.
D)can avoid the negative effects of being deprived of the funds by borrowing and using the restricted funds as collateral for the loans.

Question 5

An example of operational side effects is:

A)the use of firm personnel in competing projects.
B)the additional cost resulting from a new project.
C)the additional managerial oversight required by a new project.
D)the effect of a project on the sales of related products sold by the parent.

Question 6

Typically,a subsidiary operating in a developing country faces prohibitively high cost of capital which:

A)does not affect the subsidiary's estimate of NPV from a proposed project.
B)lowers the subsidiary's estimate of NPV from a proposed project.
C)increases the subsidiary's estimate of NPV from a proposed project.
D)may or may not affect the subsidiary's estimate of NPV for a proposed project,depending on the discount rate used.

Question 7

Differences in NPV of a proposed project between parent and subsidiary can arise from:

A)political risk or currency risk.
B)cash flow or currency asymmetries.
C)cash flow or cost-of-capital asymmetries.
D)political risk or economic risk.

Question 8

If the NPV estimates for a project are different as to the subsidiary and aas to the parent,then _________________ exists.

A)asymmetry
B)symmetry
C)parity
D)equality

Question 9

In general,in capital budgeting,cash flows resulting from financing are:

A)the most important source of cash flow since significant projects usually require a firm to borrow funds.
B)not considered because the discount rate used in valuing cash flows takes into consideration cash flows resulting from financing.
C)not considered because financing does not produce usable cash flows for a firm.
D)one of the cash flows considered and are equal to cash flows related to operations and investing.

Question 10

Parent-subsidiary asymmetry can arise from forecasting difference between the parent and the subsidiary that can arise because:

A)subsidiaries may be estimating cash flow in one currency and the parent may be estimating cash flow in another currency.
B)parents often do not inform subsidiaries of all of the information that the parent uses in its forecasts.
C)subsidiaries can have a positive bias that causes them to overestimate positive cash flow in order to make projects they want to pursue more attractive.
D)parents often encourage subsidiaries to be aggressive in their estimations of positive future cash flow.

Question 11

Typically,a subsidiary operating in a developing country faces prohibitively high cost of capital which:

A)does not affect the parent's estimate of NPV from the proposed project.
B)makes the parent's real cost of capital in its home market lower and increases the parent's estimate of NPV from the proposed project.
C)makes the parent's real cost of capital in its home market higher and decreases the parent's estimate of NPV from the proposed project.
D)makes the parent's real cost of capital in its home market higher and increases the parent's estimate of NPV from the proposed project.

Question 12

The restrictions on the ability of a foreign subsidiary to remit its profits to its parent result in:

A)restricted accounts.
B)sinking funds.
C)blocked funds.
D)political risk.

Question 13

What affect do below market interest rates in the foreign country where a subsidiary will operate have on the NPV calculations for a proposed project by the subsidiary?

A)The below market interest rate in the foreign country will result in a higher NPV to the subsidiary than the NPV to the parent.
B)The below market interest rate will quickly attract firms seeking loans,and the below market rates will rise quickly,negating any benefit to the parent or the subsidiary.
C)The below market interest rates in the foreign country will result in a higher NPV to the parent than the NPV to the subsidiary.
D)Financing cash flows are not considered in NPV calculations,so interest rates will not affect the NPV calculations.

Question 14

The cash flow realized by a parent is equal to:

A)the cash flow received from its subsidiary plus the taxes that the parent owes on that cash flow in the home-country.
B)the cash flow received from its subsidiary.
C)the cash flow received from its subsidiary minus the taxes that the parent owes on that cash flow in the home-country.
D)the cash flow received from its subsidiary minus the taxes that the subsidiary owes in the host-country.

Question 15

After-tax cash flow of a subsidiary may differ from the after-tax cash flow of the parent because:

A)the after-tax cash flow of a subsidiary is expressed in one currency and the after-tax cash flow of the parent is expressed in another currency.
B)cash flow is calculated differently in different countries,so the cash flow of a subsidiary is likely to be calculated differently than the cash flow of the parent.
C)the after-tax cash flow of the subsidiary may be subject to additional taxes before it can be considered after-tax cash flow of the parent.
D)tax treaties result in differences in after-tax cash flow form country to country.

Question 16

The additional burden imposed when the host-country of a subsidiary taxes the subsidiary's income and then that income is taxed again when it is paid to the MNC parent can be relieved by tax treaty provisions that provide for:

A)not including the subsidiary's profit in the parent's income.
B)not requiring the subsidiary to pay taxes in the host-country.
C)the MNC to elect whether it wants the subsidiary's profits taxed in the host-country or the home-country.
D)tax credits that allow the MNC to reduce the taxes it owes to the home-country by the taxes paid by the subsidiary to the host-country.

Question 17

_______________________ is a well-known problem in capital budgeting and occurs when supporters of a proposed project present the best scenario for the project so that it will have a better chance of being approved.

A)Parent-subsidiary asymmetry
B)Requester bias
C)The invalid estimate
D)The exaggerated estimate

Question 18

In considering the value of a project,the NPV estimates for the subsidiary equals the:

A)foreign cash flow from the project discounted at the parent's discount rate.
B)foreign cash flow from the project discounted at the appropriate foreign discount rate.
C)domestic cash flow discounted at the foreign discount rate.
D)domestic cash flow discounted at the domestic discount rate.

Question 19

Effective tax rate is reflected by the difference:

A)between pre-tax cash flow and after-tax cash flow.
B)in the tax rates in the host-country and home-country.
C)in the subsidiary's tax rate and the MNC's tax rate.
D)a firm's cost of capital and the discount rate it uses in computing NPV of projects.

Question 20

In some situations,the profits earned by a subsidiary cannot be immediately paid to the parent because of:

A)restrictions on how much of the profit of a foreign subsidiary can be remitted to the parent imposed by the country where the parent is located.
B)international trade restrictions that limit the amount of capital flow from country to country.
C)restrictions on remittances from the subsidiary to the parent imposed by the country where the subsidiary is located.
D)the lack of liquidity in the assets of the subsidiary that would allow the subsidiary to send cash to the parent.

Question 21

The value of the real option to abandon depends heavily on:

A)the laws of the country where the project is located.
B)the salvage value of the equipment acquired for the project.
C)the discount rate that was used in determining the NPV of the project.
D)the subsidiary's WACC.

Question 22

International projects are often undervalued when traditional capital budgeting approaches are used because traditional capital budgeting approaches:

A)use too many estimates of value.
B)use unrealistic discount rates.
C)are inadequate with regard to international projects.
D)do not consider the value of real options.

Question 23

The option to alter operating scale generally requires pre-planning so that project output can be changed quickly to meet demand,but that pre-planning involves:

A)a waste of assets since the plans that are made for the future alteration of operating scale may never be used.
B)an option premium in the nature of the extra investment that is required in case the operating scale needs to be altered.
C)abandoning other projects that the firm might profitably pursue.
D)seeking projects that have an estimated NPV in excess of 1.

Question 24

How can currency valuation issues provide firms with the real option of altering inputs?

A)Firms can buy currencies with lower values and use those currencies to buy necessary inputs for production.
B)A firm can speculate in currencies in an effort to offset production losses.
C)Firms with multiple locations can transfer inputs from location to location.
D)A firm can establish production facilities in several countries and shift production to countries with weak currencies to reduce production costs.

Question 25

Valuing an option to expand includes

A)the added value that will be received from the expended production that will result in the expansion.
B)the net cost of the expansion.
C)treating the expansion as a separate project and determining a NPV for the new project.
D)only the additional profit that the firm will receive as a result of increased production.

Question 26

How might a firm efficiently anticipate that a project might grow in size so that it could adjust easily to such growth?

A)The firm could borrow extra funds initially to use in case demand exceeded expectations.
B)The firm could build,rent or take an option for increased capacity to accommodate demand in excess of the demand originally anticipated.
C)The firm could wait to commit to the project until the demand was known.
D)The firm could contract with competitors to produce to meet any demand that the firm could not meet.

Question 27

If a firm has an option to alter operating scale and decides that the operating scale should be altered,either positively or negatively,that decision may be thought of as the:

A)first step toward the eventual abandonment of the project.
B)investment of additional funds to increase or decrease production.
C)decision that must be made at the highest level of the firm.
D)exercise of the option to alter operating scale.

Question 28

The real option to alter inputs not only means changing the types of materials used for production,it can also involve:

A)shifting between various suppliers of the same material.
B)buying required materials at attractive prices and stockpiling them for later use.
C)changing the type of product that is produced.
D)entering a new market for the products produced.

Question 29

The most common option in international projects is the option to:

A)abandon.
B)grow.
C)expand.
D)alter inputs.

Question 30

While the ability to modify a project as it develops may be viewed as a positive attribute of the project,it also means that:

A)the project is not very well planned.
B)more decisions will potentially have to be made about the project.
C)the project will always be in danger of failing.
D)the project will cost more than originally projected.

Question 31

If a firm expects that if it undertakes a specific project,the experience gained from that project will lead it to other related opportunities,that project includes the:

A)possibility of the need for additional funding.
B)real option to grow.
C)real option to alter inputs.
D)opportunity for additional profits.

Question 32

If a firm plans a project so that it can,if necessary,not pursue the project,it has a real option to:

A)alter scale.
B)reject.
C)abandon.
D)alter inputs.

Question 33

What pre-planning can a firm do in anticipation that the demand for products produced by a project will not meet expectations?

A)The firm can wait until the demand is determined before committing to the project.
B)The firm can arrange for a buyer to buy the project in the event that demand is below expectations.
C)The firm can arrange to outsource components of the product and can use temporary labor that can be reduced quickly.
D)The firm can produce as expected despite the demand.

Question 34

One of the approaches that can be used in making the decision to expand that involves creating a model of possible decisions and the short and longer term consequences of each decision is the:

A)operational decision model.
B)decision tree method.
C)truth table approach.
D)mathematical modeling approach.

Question 35

Modification to projects undertaken by MNCs:

A)are often required.
B)are resisted at all costs.
C)should never be required.
D)indicate that the project was flawed from the inception.

Question 36

The option to ___________________ allows a firm to change the scale of a project after committing to the project.

A)alter operating scale
B)abandon
C)grow
D)alter inputs

Question 37

If a firm decides,after it has begun a project that the project will not produce value for the firm,how can the firm get the most value out of the project?

A)Continue the project and hope for more value than anticipated.
B)Change the inputs for the project to increase value.
C)Transfer the project to a subsidiary in a low-cost country.
D)Sell the assets purchased for the project for salvage value.

Question 38

In an industry that requires high levels of human capital,the option to abandon:

A)has relatively little value.
B)is of the utmost importance.
C)has diminished value but the option is still very valuable.
D)has not value whatsoever.

Question 39

_______________________ is defined as the ability to fine-tune a project after pursuit of the project has begun.

A)Project flexibility
B)Sunk cost
C)The option to alter
D)The option to abandon

Question 40

In the international context,barriers to entry into certain markets include:

A)costs and difficulty of creating new products.
B)lax environmental regulations and consumer protection laws.
C)complex regulations and diversity of consumer demands.
D)lack of understanding of local customs and competition.

Question 41

A firm can make an option to abandon more realistic by:

A)leasing the production facility rather than buying it.
B)acquiring insurance that will protect it in the event of abandonment.
C)not discussing with local government an intention to abandon a project.
D)investing as little as possible in the project initially.

Question 42

The exercise price of the real option to abandon is:

A)payouts necessary to terminate leases and employees and payoffs to local government officials.
B)payouts necessary to terminate leases and employees and taxes,regulatory or financing penalties.
C)payouts to terminate leases and employees and the cost of transporting project assets back to the parent's premises.
D)payouts to terminate leases and employees and damage to the firm's reputation.

Question 43

How do remittance restrictions impact the cash flow to the parent from a project?

Question 44

What are real options and how do they affect the estimated value of projects?

Question 45

In valuing real options for international projects,one of the key factors is:

A)political risk.
B)economic risk.
C)currency volatility.
D)the discount rate.

Question 46

What are side effects and how are they related to the value of international projects?

Question 47

The simplest way to exercise the real option to abandon is to:

A)stop production before any more money is lost.
B)turn project assets over to local government.
C)invest enough money so that the project does not have to be abandoned.
D)fulfill existing contracts and then sell remaining assets.

Question 48

One of the potential special problems with an option to abandon is that:

A)it can cost the firm more than the original investment.
B)competitors will try to buy the project at a reduced price.
C)there may be restrictions in the foreign country where the project is located that prevent or complicate abandonment of the project.
D)the parent may not want to abandon the project.

Question 49

What factors should those responsible for deciding whether to pursue a project consider if there are value differences when the project is considered from the parent's viewpoint and the subsidiary's viewpoint?

Question 50

What are the causes of parent-subsidiary asymmetry?