Appraisal of foreign direct investment - Essay Example

A review of capital structure of FUSE plc has also been undertaken. Foreign direct investment implies transfer of capital, managerial, and technical assets by a multinational entity from the country where it is based to the country where investment is made. FDI may involve participation by the host country in equity capital, managerial control, and operational control. FDI decisions are complex issues as FDI projects are subjected to a variety of risk factors. For the case under study the FUSE plc has set up certain criterion for taking a decision for investment in a power generating project in Pajistan.

The basic rule for investment decisions is that the internal rate of return on the project should be greater than the weighted marginal cost of the investment. The rule dictates that “accept projects up to the point at which the marginal return on an investment equals its weighted cost of capital. Beyond that point, its investment return will be less than its capital cost.” (Lawrence J. Gitman, page 519)i However, the investment criterion of FUSE Plc for investment in emerging market like Pajistan is three fold as under: As per above criterion of investment, the computations of hurdle rate become imperative.

Hurdle rate is the “minimum acceptable rate of return for a proposed project to merit investment. Usually, the hurdle rate is the opportunity cost of capital or the best return the company could get by investing the capital elsewhere. To be financially justifiable, a project’s internal rate of return must exceed the hurdle rate set by the firm for such project.”(Paul M. Swamidass, page 286)ii FUSE plc has set its hurdle rate for Pajistan project at 5% above the weighted cost of average capital to the company.

Accordingly computations of WACC are important to devise the required hurdle rate. It is important to note that “cost of capital is the rate of return that a firm must earn on the projects, in which it invests to maintain the