Question 1

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.

Accepted Answer

A project might have a positive NPV from the local viewpoint, but fail to consider relevant cash flows from the parent viewpoint. For example, a positive NPV project in one country may result from the erosion of revenues in another. A local manager would not necessarily be expected to be aware of such erosion. It may not be possible to remit all or part of the local cash flows to the parent company and reinvestment opportunities in the local economy may be inferior to what the parent could do elsewhere, thus, a less than maximum use of funds. Political and exchange rate risk add to the uncertainty of cash flows and thus increase the required rate of return by stockholders. Cash flows may be more difficult to estimate especially long-term cash flows in lesser-developed countries.

Question 2

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

Accepted Answer

All the options listed (A, B, and C) are reasons why capital budgeting for a foreign project is more complex than for a domestic project, making D the correct choice as it states that all the given reasons add complexity to the process.

Question 3

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

Accepted Answer

All the options listed (A, B, and C) are indeed steps in the capital budgeting process. Identifying the initial capital investment, estimating future cash flows, and determining the appropriate discount rate are all fundamental aspects of evaluating potential investments or projects.

Question 4

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

Accepted Answer

Evaluating a project from a local viewpoint can provide valuable insights and feedback on how the project is meeting the needs of the community or area it is serving. However, it is important to also consider the perspective of the project's parent organization or stakeholders to ensure that the project aligns with larger goals and objectives. Therefore, the local viewpoint should be subordinated to the parent's viewpoint in project evaluation.

Question 5

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.

Accepted Answer

The proper way to estimate the NPV of a foreign project is to discount the appropriate cash flows at the appropriate discount rate, which should account for factors such as exchange rate risk and country risk. The cash flows should then be converted to the domestic currency at the expected future exchange rate, not the current spot rate.

Question 6

For purposes of international capital budgeting, which of the following statements is NOT true?

Accepted Answer

All the statements provided are true in the context of international capital budgeting. Political risk assessment is crucial due to its potential impact on cash flows. Differentiating between parent and project cash flows is important for a comprehensive valuation, and nonfinancial payments can indeed create cash flows between subsidiaries and the parent company.

Question 7

For purposes of international capital budgeting, parent cash flows often depend on the form of financing. Thus, we cannot clearly separate cash flows from financing decisions, as we can in domestic capital budgeting.

Accepted Answer

International capital budgeting involves factors such as exchange rates and different tax laws that impact the cash flows and financing decisions of a parent company, making it difficult to separate the two.

Question 8

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

Accepted Answer

All of the given options are examples of political risk.

Question 9

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

Accepted Answer

Capital budgeting is the traditional financial analysis used to determine the value of a project to the firm. It involves assessing the cash inflows and outflows of the project, evaluating the project's risk and return, and making a decision about whether to invest in the project. Cost of capital analysis is a component of capital budgeting, while capital structure analysis and agency theory are broader concepts in finance.

Question 10

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

Accepted Answer

There are several important differences between domestic and international capital budgeting methods. International capital budgeting involves additional considerations such as foreign exchange rates, political risks, cultural differences, and legal and regulatory frameworks. These factors can significantly impact the evaluation and decision-making process in international capital budgeting. Therefore, international capital budgeting methods need to consider these factors and incorporate them into the analysis.

Question 11

For purposes of international capital budgeting, evaluation of a project from the PARENT viewpoint serves some useful purposes, but it should be subordinated to evaluation from the LOCAL's viewpoint.

Accepted Answer

Evaluation from the LOCAL's viewpoint should be given priority in international capital budgeting as it takes into account local market conditions, regulations, and cultural factors that may impact the success of the project. The PARENT viewpoint, while important, may not fully capture these factors.

Question 12

In international capital budgeting, the appropriate discount rate for determining the present value of the expected cash flows is always the firm's domestic WACC.

Accepted Answer

The appropriate discount rate for determining the present value of the expected cash flows in international capital budgeting should be adjusted for the risks and uncertainties associated with the particular foreign investment. Therefore, the firm's domestic WACC may not be appropriate in all cases. The use of country-specific risk premiums or adjustments to the discount rate may be necessary to account for differences in risk between the domestic market and the foreign market.

Question 13

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

Accepted Answer

According to Accounting Standards Codification (ASC) 810, a subsidiary must be consolidated if the parent company owns more than 50% of the subsidiary's outstanding voting shares, or has the power to control the subsidiary's operations. Therefore, the correct answer is C) 50%.

Question 14

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

Accepted Answer

The answer of Affiliate firms are consolidated on the parent's...

Question 15

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

Accepted Answer

The accounting rate of return (ARR) does not use discounted cash flows but instead compares the average annual profit of a project to the initial investment. The other capital budgeting decision criteria, such as net present value and internal rate of return, use discounted cash flows to account for the time value of money.

Question 16

When engaged in international capital budgeting, the analyst must identify the initial amount of capital invested or put at risk.

Accepted Answer

This statement is true. In international capital budgeting, the analyst needs to identify the initial amount of capital invested or put at risk in order to evaluate the returns and risks associated with the investment.

Question 17

For purposes of international capital budgeting, it is NOT important to distinguish between parent and total project cash flows.

Accepted Answer

It is important to distinguish between parent and total project cash flows in international capital budgeting because the parent cash flows only represent the cash flows attributable to the parent company, while total project cash flows represent the cash flows of the entire project including any cash flows that may be generated by the subsidiary or foreign affiliate. This distinction is important because it affects how the cash flows are measured and evaluated for investment decisions.

Question 18

Multinational firms should invest only if they can earn a risk-adjusted return greater than locally based competitors can earn on the same project.

Accepted Answer

This is because multinational firms typically face additional risks and costs related to operating in multiple countries, such as political and currency risks, as well as expenses associated with managing a global supply chain. Therefore, they need to earn a higher return to offset these additional costs and risks and justify their investment. If they cannot earn a risk-adjusted return greater than what local competitors can earn, it may not make financial sense for them to invest in the project.

Question 19

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

Accepted Answer

Adopting a common standard for the capital budgeting process helps ensure that all projects are evaluated on the same basis and that the company's resources are allocated to the most promising opportunities regardless of their location. This can help prevent biases in favor of domestic projects over foreign ones, or vice versa.

Question 20

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

Accepted Answer

A foreign firm that is 20% to 49% owned by a parent company is considered an affiliate. A subsidiary is a foreign firm that is more than 50% owned by a parent company, while a partner implies a joint venture or collaboration. Rival is an independent firm that competes with another firm in the same industry.

Quiz 18: Multinational Capital Budgeting and Cross-Border Acquisitions