Deck 19: Multinational Capital Budgeting

Question 1

Use the information to answer the following question(s).
The Wheel Deal Inc., a company that produces scooters and other wheeled non-motorized recreational equipment is considering an expansion of their product line to Europe. The expansion would require a purchase of equipment with a price of euro 1,200,000 and additional installation of euro 300,000 (assume that the installation costs cannot be expensed, but rather, must be depreciated over the life of the asset). Because this would be a new product, they will not be replacing existing equipment. The new product line is expected to increase revenues by euro 600,000 per year over current levels for the next 5 years, however; expenses will also increase by euro 200,000 per year. (Note: Assume the after-tax operating cash flows in years 1-5 are equal, and that the terminal value of the project in year 5 may change total after-tax cash flows for that year.)The equipment is multipurpose and the firm anticipates that they will sell it at the end of the five years for euro 500,000. The firm's required rate of return is 12% and they are in the 40% tax bracket. Depreciation is straight-line to a value of euro 0 over the 5-year life of the equipment, and the initial investment (at year 0)also requires an increase in NWC of euro 100,000 (to be recovered at the sale of the equipment at the end of five years). The current spot rate is $0.95/euro , and the expected inflation rate in the U.S. is 4% per year and 3% per year in Europe.
Refer to Instruction 19.1. What are the annual after-tax cash flows for the Wheel Deal project?

A)€400,000
B)€240,000
C)€120,000
D)€360,000

Answer 1

€360,000

Question 2

When determining a firm's weighted average cost of capital (WACC)which of the following terms is NOT necessary?

A)The firm's weight of equity financing.
B)The risk-free rate of return.
C)The firm's weight of debt financing.
D)All of the above are necessary to determine a firm's WACC.

Answer 2

The risk-free rate of return.

Question 3

Use the information to answer the following question(s).
The Wheel Deal Inc., a company that produces scooters and other wheeled non-motorized recreational equipment is considering an expansion of their product line to Europe. The expansion would require a purchase of equipment with a price of euro 1,200,000 and additional installation of euro 300,000 (assume that the installation costs cannot be expensed, but rather, must be depreciated over the life of the asset). Because this would be a new product, they will not be replacing existing equipment. The new product line is expected to increase revenues by euro 600,000 per year over current levels for the next 5 years, however; expenses will also increase by euro 200,000 per year. (Note: Assume the after-tax operating cash flows in years 1-5 are equal, and that the terminal value of the project in year 5 may change total after-tax cash flows for that year.)The equipment is multipurpose and the firm anticipates that they will sell it at the end of the five years for euro 500,000. The firm's required rate of return is 12% and they are in the 40% tax bracket. Depreciation is straight-line to a value of euro 0 over the 5-year life of the equipment, and the initial investment (at year 0)also requires an increase in NWC of euro 100,000 (to be recovered at the sale of the equipment at the end of five years). The current spot rate is $0.95/euro , and the expected inflation rate in the U.S. is 4% per year and 3% per year in Europe.
Refer to Instruction 19.1. What is the initial investment for the Wheel Deal project?

A)$1,500,000
B)€1,600,000
C)$1,600,000
D)€1,500,000

Answer 3

$1,500,000

Question 4

Which of the following is NOT a basic step in the capital budgeting process?

A)Identify the initial capital invested.
B)Estimate the cash flows to be derived from the project over time.
C)Identify the appropriate interest rate at which to discount future cash flows.
D)All of the above are steps in the capital budgeting process.

Question 5

Of the following capital budgeting decision criteria, which does NOT use discounted cash flows?

A)Net present value.
B)Internal rate of return.
C)Accounting rate of return.
D)All of these techniques typically use discounted cash flows.

Question 6

Which of the following is NOT a reason why capital budgeting for a foreign project is more complex than for a domestic project?

A)Parent cash flows must be distinguished from project cash flows.
B)Parent firms must specifically recognize remittance of funds due to differing rules and regulations concerning remittance of cash flows, taxes, and local norms.
C)Differing rates of inflation between the foreign and domestic economies.
D)All of the above add complexity to the international capital budgeting process.

Question 7

If a firm undertakes a project with ordinary cash flows and estimates that the firm has a positive NPV, then the IRR will be ________.

A)less than the cost of capital
B)greater than the cost of capital
C)greater than the cost of the project
D)cannot be determined from this information

Question 8

The traditional financial analysis applied to foreign or domestic projects, to determine the project's value to the firm is called ________.

A)cost of capital analysis
B)capital budgeting
C)capital structure analysis
D)agency theory

Question 9

A foreign firm that is 20% to 49% owned by a parent is called a/an ________.

A)subsidiary
B)affiliate
C)partner
D)rival

Question 10

Project evaluation from the ________ viewpoint serves some useful purposes and/but should ________ the ________ viewpoint.

A)local; be subordinated to; parent's
B)local; not be subordinated to; parent's
C)parent's; be subordinated to; local
D)none of the above

Question 11

When estimating a firm's cost of equity capital using the CAPM, you need to estimate

A)the risk-free rate of return.
B)the expected return on the market portfolio.
C)the firm's beta.
D)all of the above

Question 12

For financial reporting purposes, U.S. firms must consolidate the earnings of any subsidiary that is over ________ owned.

A)20%
B)40%
C)50%
D)75%

Question 13

Use the information to answer the following question(s).
The Wheel Deal Inc., a company that produces scooters and other wheeled non-motorized recreational equipment is considering an expansion of their product line to Europe. The expansion would require a purchase of equipment with a price of euro 1,200,000 and additional installation of euro 300,000 (assume that the installation costs cannot be expensed, but rather, must be depreciated over the life of the asset). Because this would be a new product, they will not be replacing existing equipment. The new product line is expected to increase revenues by euro 600,000 per year over current levels for the next 5 years, however; expenses will also increase by euro 200,000 per year. (Note: Assume the after-tax operating cash flows in years 1-5 are equal, and that the terminal value of the project in year 5 may change total after-tax cash flows for that year.)The equipment is multipurpose and the firm anticipates that they will sell it at the end of the five years for euro 500,000. The firm's required rate of return is 12% and they are in the 40% tax bracket. Depreciation is straight-line to a value of euro 0 over the 5-year life of the equipment, and the initial investment (at year 0)also requires an increase in NWC of euro 100,000 (to be recovered at the sale of the equipment at the end of five years). The current spot rate is $0.95/euro , and the expected inflation rate in the U.S. is 4% per year and 3% per year in Europe.
Refer to Instruction 19.1. In euros, what is the NPV of the Wheel Deal expansion?

A)€1,524,690
B)$1,611,317
C)-€75,310
D)-€111,317

Question 14

Use the information to answer the following question(s).
The Wheel Deal Inc., a company that produces scooters and other wheeled non-motorized recreational equipment is considering an expansion of their product line to Europe. The expansion would require a purchase of equipment with a price of euro 1,200,000 and additional installation of euro 300,000 (assume that the installation costs cannot be expensed, but rather, must be depreciated over the life of the asset). Because this would be a new product, they will not be replacing existing equipment. The new product line is expected to increase revenues by euro 600,000 per year over current levels for the next 5 years, however; expenses will also increase by euro 200,000 per year. (Note: Assume the after-tax operating cash flows in years 1-5 are equal, and that the terminal value of the project in year 5 may change total after-tax cash flows for that year.)The equipment is multipurpose and the firm anticipates that they will sell it at the end of the five years for euro 500,000. The firm's required rate of return is 12% and they are in the 40% tax bracket. Depreciation is straight-line to a value of euro 0 over the 5-year life of the equipment, and the initial investment (at year 0)also requires an increase in NWC of euro 100,000 (to be recovered at the sale of the equipment at the end of five years). The current spot rate is $0.95/euro , and the expected inflation rate in the U.S. is 4% per year and 3% per year in Europe.
Refer to Instruction 19.1. What is the IRR of the Wheel Deal expansion?

A)14.4%
B)10.3%
C)12.0%
D)8.6%

Question 15

When evaluating capital budgeting projects, which of the following would NOT necessarily be an indicator of an acceptable project?

A)an NPV > $0
B)an IRR > the project's required rate of return
C)an IRR > $0
D)All of the above are correct indicators.

Question 16

Affiliate firms are consolidated on the parent's financial statements on a ________ basis.

A)pro rated
B)50%
C)75%
D)100%

Question 17

When determining a firm's weighted average cost of capital (wacc)which of the following terms is NOT necessary?

A)The firm's tax rate.
B)The firm's cost of debt.
C)The firm's cost of equity.
D)All of the above are necessary.

Question 18

Given a current spot rate of 8.10 Norwegian krone per U.S. dollar, expected inflation rates of 3% in Norway and 6% per annum in the U.S., use the formula for relative purchasing power parity to estimate the one-year spot rate of krone per dollar.

A)7.87 krone per dollar
B)8.10 krone per dollar
C)8.34 krone per dollar
D)There is not enough information to answer this question.

Question 19

Use the information to answer the following question(s).
The Wheel Deal Inc., a company that produces scooters and other wheeled non-motorized recreational equipment is considering an expansion of their product line to Europe. The expansion would require a purchase of equipment with a price of euro 1,200,000 and additional installation of euro 300,000 (assume that the installation costs cannot be expensed, but rather, must be depreciated over the life of the asset). Because this would be a new product, they will not be replacing existing equipment. The new product line is expected to increase revenues by euro 600,000 per year over current levels for the next 5 years, however; expenses will also increase by euro 200,000 per year. (Note: Assume the after-tax operating cash flows in years 1-5 are equal, and that the terminal value of the project in year 5 may change total after-tax cash flows for that year.)The equipment is multipurpose and the firm anticipates that they will sell it at the end of the five years for euro 500,000. The firm's required rate of return is 12% and they are in the 40% tax bracket. Depreciation is straight-line to a value of euro 0 over the 5-year life of the equipment, and the initial investment (at year 0)also requires an increase in NWC of euro 100,000 (to be recovered at the sale of the equipment at the end of five years). The current spot rate is $0.95/euro , and the expected inflation rate in the U.S. is 4% per year and 3% per year in Europe.
Refer to Instruction 19.1. What is the NPV of the European expansion if Wheel Deal first computes the NPV in euros and then converts that figure to dollars using the current spot rate?

A)$1,520,000
B)$1,684,210
C)-$75,310
D)-$71,544

Question 20

Given a current spot rate of 8.10 Norwegian krone per U.S. dollar, expected inflation rates of 6% in Norway and 3% per annum in the U.S., use the formula for relative purchasing power parity to estimate the one-year spot rate of krone per dollar.

A)7.87 krone per dollar
B)8.10 krone per dollar
C)8.34 krone per dollar
D)There is not enough information to answer this question.

Question 21

Which of the following is NOT an example of political risk?

A)Expropriation of cash flows by a foreign government.
B)The U.S. government restricts trade with a foreign country where your firm has investments.
C)The foreign government nationalizes all foreign-owned assets.
D)All of the above are examples of political risk.

Question 22

There are no important differences between domestic and international capital budgeting methods.

Question 23

When dealing with international capital budgeting projects, the value of the project is NOT sensitive to the firm's cost of capital.

Question 24

Generally speaking, a firm wants to receive cash flows from a currency that is ________ relative to their own, and pay out in currencies that are ________ relative to their home currency.

A)appreciating; depreciating
B)depreciating; depreciating
C)appreciating; appreciating
D)depreciating; appreciating

Question 25

________ is the risk that a foreign government will place restrictions such as limiting the amount of funds that can be remitted to the parent firm, or even expropriation of cash flows earned in that country.

A)Exchange risk
B)Foreign risk
C)Political risk
D)Unnecessary risk

Question 26

The authors highlight a strong theoretical argument in favor of analyzing any foreign project from the viewpoint of the parent. Provide at least three reasons why the parent's viewpoint is superior to the local viewpoint and give an example of when the local viewpoint fails to maximize the value of the firm.

Question 27

It is important that firms adopt a common standard for the capital budgeting process for choosing among foreign and domestic projects.

Question 28

Explain how political risk and exchange rate risk increase the uncertainty of international projects for the purpose of capital budgeting.

Question 29

Real option analysis allows managers to analyze all of the following EXCEPT:

A)the option to defer.
B)the option to abandon.
C)the option to alter capacity.
D)All of the above may be analyzed using real option analysis.

Question 30

Project financing is the arrangement of financing for very large individual long-term capital projects.

Question 31

The only proper way to estimate the NPV of a foreign project is to discount the appropriate cash flows first and then convert them to the domestic currency at the current spot rate.

Question 32

Which of the following is NOT a factor critical to the success of project financing?

A)Separability of the project from its investors.
B)Long-lived and capital intensive singular projects.
C)Cash flow predictability from third part commitments.
D)All of the above are critical factors for project financing.