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Exam 14: Multinational Capital Budgeting

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Question 41

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Assume an MNC establishes a subsidiary where it has no other existing business. The present value of parent cash flows from this subsidiary is more sensitive to exchange rate movements when:

A) the subsidiary finances the entire investment by local borrowing.
B) the subsidiary finances most of the investment by local borrowing.
C) the parent finances most of the investment.
D) the parent finances the entire investment.

E) B) and D)
F) None of the above

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Question 42

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Exhibit 14-1 Assume that Baps Corporation is considering the establishment of a subsidiary in Norway. The initial investment required by the parent is $5,000,000. If the project is undertaken, Baps would terminate the project after four years. Baps' cost of capital is 13%, and the project is of the same risk as Baps' existing projects. All cash flows generated from the project will be remitted to the parent at the end of each year. Listed below are the estimated cash flows the Norwegian subsidiary will generate over the project's lifetime in Norwegian kroner (NOK) : $\begin{array}{llcc}\underline{\text { Year 1 }} & \underline{\text { Year 2 }}& \underline{\text { Year 3 }}& \underline{\text { Year 4 }} \\\text { NOK10.000.000 }&\text { NOK15.000.000 }& \text { NOK17.000.000 }& \text { NOK20.000.000 }\\\end{array}$ The current exchange rate of the Norwegian kroner is $.135. Baps' exchange rate forecast for the Norwegian kroner over the project's lifetime is listed below: $\frac { \text { Year 1 } } { \$ 13 } \quad \frac { \text { Year 2 } } { \$ 14 } \quad \frac { \text { Year 3 } } { \$ 12 } \quad \frac { \text { Year 4 } } { \$ .15 }$ -Refer to Exhibit 14-1. Assume that NOK8,000,000 of the cash flow in year 4 represents the salvage value. Baps is not completely certain that the salvage value will be this amount and wishes to determine the break-even salvage value, which is $____.

A) 510,088.04
B) 1,710,088
C) 1,040,000
D) none of the above

E) B) and C)
F) A) and B)

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Question 43

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Exhibit 14-1 Assume that Baps Corporation is considering the establishment of a subsidiary in Norway. The initial investment required by the parent is $5,000,000. If the project is undertaken, Baps would terminate the project after four years. Baps' cost of capital is 13%, and the project is of the same risk as Baps' existing projects. All cash flows generated from the project will be remitted to the parent at the end of each year. Listed below are the estimated cash flows the Norwegian subsidiary will generate over the project's lifetime in Norwegian kroner (NOK) : $\begin{array}{llcc}\underline{\text { Year 1 }} & \underline{\text { Year 2 }}& \underline{\text { Year 3 }}& \underline{\text { Year 4 }} \\\text { NOK10.000.000 }&\text { NOK15.000.000 }& \text { NOK17.000.000 }& \text { NOK20.000.000 }\\\end{array}$ The current exchange rate of the Norwegian kroner is $.135. Baps' exchange rate forecast for the Norwegian kroner over the project's lifetime is listed below: $\frac { \text { Year 1 } } { \$ 13 } \quad \frac { \text { Year 2 } } { \$ 14 } \quad \frac { \text { Year 3 } } { \$ 12 } \quad \frac { \text { Year 4 } } { \$ .15 }$ -Refer to Exhibit 14-1. What is the net present value of the Norwegian project?

The required rate of return used to discount the relevant cash flows from a foreign project may differ from the MNC's cost of capital because of that particular project's risk.