Some Issues of International Business Finance - Case Study Example

International Business Finance The Cost Benefits Appraisal Techniques From the two scenarios, it is probable to synchronize the presents and the execution of a system of control where the nature and contours are considerably similar from each others perspective. In connection to the focus of control, it is notable that the two international joint investments, the foreign parent firm and the local based subsidiary in Germany are assigned exact and unique zone of control. Hence the partners in Germany create an operational and decentralized form of control (Varshney & Maheshwari, 2010; p. 881). Particular operational functions are prone to specific considerations. There is transfer of technology between the subsidiaries and the parent firm in the joint venture and the industrial output of the joint venture. Therefore the following can be noted from the joint venture under the strategic option 1. In this multinational capital budgeting there are various factors as well as assumptions that were taken into consideration to determine the expected returns from the joint venture from the parent’s firm perspective. First and foremost the exchange rates fluctuations were taken into account especially when converting the subsidiary earnings into the parent firm’s reporting currency. Given that is challenging to precisely estimate the rates of exchange rates, the determination of the expected returns in pounds were established using the spot exchange rate of £0.8410/€. Besides, the cost of inflation was taken into account which was charged on the cost of operations to incorporate the depreciation rates and the interest rates on loans based in Germany borrowing rates. Even though the prediction of costs or price completely takes into account the inflation, the rates of inflation rates at tikes can be volatile from one year to another for some states (Madura, 2011; p. 49). Hence the cost of inflation from the Germany perspective was taken to be 2.5%. Lastly, the financial arrangements were put into account. These include the costs of finance which is captured by the rate of discount and the taxation rate. Nonetheless, when the foreign based projects are partly financed using the subsidiaries in the foreign nations, a more precise strategy is applied to distinguish the investment in the subsidiary and openly take into account the loan repayment of the foreign loans as cash outflows. Moreover, the returns from the Germany were not taxed due to the double taxation treaty that exists between Germany and United Kingdom. The following calculations can be noted under strategic option One; the perspective from the parent’s view is more relevant especially when conducting an evaluation of the project. Since any investment that can bring in a positive net present value for the parent firm must boost the value of the firm. Joint perspective (strategy option 1)         Gross Cash flows in Year 1 Year 2 year 3 year4 Euro zone € 900,000.00 € 1,035,000.00 € 1,190,250.00 € 1,368,787.50 Cost of operation € 235,000.00 € 235,000.00 € 235,000.00 € 235,000.00 Inflation rate 2.5% € 240,875.00 € 240,875.00 € 240,875.00 € 240,875.00 interest rate cost € 70,000.00 € 70,000.00 € 70,000.00 € 70,000.00 Total costs € 310,875.00 € 310,875.00 € 310,875.00 € 310,875.00 Expected returns from subsidairy € 589,125.00 € 724,125.00 € 879,375.00 € 1,057,912.50 Tax rate (29%) € 170,846.25 € 209,996.25 € 255,018.75 € 306,794.63 Net Returns in euros € 418,278.75 € 514,128.75 € 624,356.25 € 751,117.88 Net returns in pounds £ 351,772.43 £ 432,382.28 £ 525,083.61 £ 631,690.13 UK investments £ 450,000.00 £ 517,500.00 £ 595,125.00 £ 684,393.75 Tax rate in UK 29% £ 130,500.00 £ 150,075.00 £ 172,586.25 £ 198,474.19 Net returns in UK £ 319,500.00 £ 367,425.00 £ 422,538.75 £ 485,919.56 Total cash inflows from parents £ 671,272.43 £ 799,807.28 £ 947,622.36 £ 1,117,609.70 Assumptions         No taxation of the Germany returns         This means that from the parent’s perspective the net cash inflows is about £ 1,117,609.70 by the end of year 4. This is the total cash inflows at the end of year 4 in the perspective of the joint venture with consideration of the taxation rates. Since there exist a double taxation treaty between UK and Germany, the returns from Germany denominated in Euros were not taxed but the returns in both countries were taxed separately given that tax policies in very country demands that all incomes and returns be taxed according to the country’s standard rates. It was also assumed that the tax rates in both countries were same; that is 29%. In this case it can be said that this strategic option offers positive returns for the IMF PLC. However, comparing the total costs of operations this option might be attractive since the total costs of this joint venture is about € 4 million Euros which is about £ 3,364,000 against an accumulation return of £ 3,536,311.76 where the profit is about £ 172,311.76. The Net Present Value Appraisal Techniques Under the strategic Option two; there are also several factors that were put into account. This strategy has a decision of whether to restructure the company or move the parent firm from France to Monaco. This will entail shifting the parent firm from France to re-domiciling to Monaco. It has been estimated by the finance director that will call for net funding of an equivalent € 5 million Euros. The board has already made a decision that a diversification over Asia even though some facts and data on the available alternatives of sources of finance for the project to assess in the following board meeting. The following was taken into consideration; whether or not there were blocked funds since some states stipulate that earnings generated by the subsidiary be re-ventured domestically for at least a particular period of time prior to be repatriated back to the parent firm (Saudagaran, 2009; p. 21). No information on possibility of existing blocked funds between Germany and United Kingdom hence it was assumed in this case that there were no blocked funds. The unpredictable salvage value for the project was assumed to be zero. Since the salvage value essentially has a considerable effect on the NPV of the project, the multinational corporation IMF Plc might need to make computation of the breakeven salvage value. The investment on the prevailing cash flows especially the proposed new project might rival with the current business for some clients. This was assumed to be marginal since no market analysis of the new markets has been provided intensively hence the calculations were conducted purely from assumptions the new markets will have similar challenges as the existing markets. Besides the incentives offered by the host state were also incorporated into the evaluation especially the double taxation treaty that was signed between the two states. Last but very important, the real options for extra business avenues or platforms were also put into consideration when determining the net present value (Ehrhardt & Brigham, 2010; p. 51). The value of such actual options relies on the possibility of implementing the option and the resultant Net present Value. In this case the real options were not used in the computation of the Net present value. This can be illustrated by the computation below of the NPV. The cost of capital that was applied was assumed to to be equivalent to be return on yields which was 12%. The yearly cash inflows were the yearly profits from the investment which was €1,800,000 for a period of five years. Strategy option 2           Cost of capital (WACC) 12%         Cash outflow Year 0 Year 1 Year 2 year 3 year 4   € (5,000,000.00)         Profits   € 1,800,000.00 € 1,800,000.00 € 1,800,000.00 € 1,800,000.00 cost of capital 12%   € 2,016,000.00 € 2,257,920.00 € 2,528,870.40 € 2,832,334.85 Net present value € 7,807,340.28         Taking into account the tax rate € 5,543,211.60         Year 5 NPV b4 taxation     € 1,800,000.00   € 3,172,215.03 € 12,807,340.28 Cost Benefit Analysis From the cost benefit appraisal technique the project is assessed based on the desirable expectation from the investors. The general rule is to evaluate whether or not the economic benefits related with the investment is higher than its economic costs. If the benefits exceed the costs then the project will be desirable by the shareholders. This might not essentially imply that the project goes on compared to another project with a higher NPV. Hence this method of appraisal must be followed with an evaluation of the NPV of the project (Triantis, 1999; p. 4). All the appropriate costs inclusive of indirect costs and benefits are put into account and the benefits that accrue to the project are also analyzed inclusive of any taxation exempts which will give a rough picture of the viability of the project. Hence the conclusion must not be used to judge the viability. Net Present Value Method (NPV) This method is normally considered to be the best method of project appraisal. The revenues and costs of the investment are projected and then discounted and finally put to comparison with the initial outlay. The project with the highest NPV will be preferred in most cases while those with negative NPV will be rejected since it will be difficult for the company to recover the costs of outlay. Compared to other appraisal method, this is the most reliable method regardless of the few disadvantages presented in the international project analysis. Such risks as Political risks might not be incorporated due to its nature of stability that can easily overnight to render the project very risky (Baker & English, 2011; p. 3). Bibliography Baker, H. K., & English, P 2011, Capital budgeting valuation: Financial analysis for todays investment projects. Hoboken, N.J: Wiley. Ehrhardt, M. C., & Brigham, E. F 2010, Corporate finance: A focused approach. New York: South-Western [u.a.. Madura, J 2011, Financial Markets and institutions. Cengage Learning. Saudagaran, S. M. (2009). International accounting: A user perspective. Chicago, IL: CCH. Triantis, J. E 1999, Creating successful acquisition and joint venture projects: A process and team approach. Westport, Conn: Quorum. Varshney, R.L. & K.L. Maheshwari 2010, Manegerial Economics. 23 Daryaganj, New Delhi 110002: Sultan Chand & Sons. p. 881. Read More