International Project Appraisal 71321w

Why international projects • Economies of scale: As the domestic market saturates it starts viewing overseas market as a potential source of growth , continuous growth is essential for achieving further economies of scale • Comparative Advantage: The locational advantage offered by a country by way of lower costs serve as an important incentive

• Vertical diversification :companies going for vertical diversification may sometimes need to expand overseas due to non availability of opportunities in the domestic market. • General Diversification Benefits : A corporate may like to invest overseas for the benefits of diversification across various markets

• Attacking Foreign Competition : – a)Cost advantage of competitors home country – b)attention diversion to home country Extension of existing International Operations For a corporate exporting goods ,establishing a foreign subsidiary may be a natural extension.

• Product Life Cycle : As a product moves to maturity stage its production process becomes more standardised and developing countries with lower cost of production become come forward to try and move prodcution facilities to their countries. • Non transferable knowledge: Sometimes due to reluctance in sharing the knowledge or secrets companies have to set up their own units to enter foreign lands.Example coca cola

• Brand Equity: Companies with a good brand equity have an incentive to expand overseas as they see marketing would be easier. For example Levis set up operations in India to exploit its international reputation as a producer of good quality denim • Protection of Brand Equity: Sometimes to maintain high quality standards the companies shy from giving licenses and prefer to establish their own manufacturing units

• Following its Clients :Some service firms may find it both attractive and necessary to expand along with their clients.Example major auditing firms generally extend their operations to countries where their clients expand , because of their clients requirements to have single auditor across the globe.

Appraisal of foreign investment • Appraisal is required for – Cash flow and associated risk Actual cash flow

Exchange rate Political , social economic risk

Some basic principles for cash flow estimation • Incremental cash flows are considered • Any resource used is valued at opportunity cost • Sunk costs are ignored in present investment analysis • Investments and financing decesions are treated seperately • Added cash flows from investment decesions are considered • Non cash elements are not considered • After tax cash flows are taken into

Incremental cash flows • Incremental rather than absolute cash flow in considered, this takes into the effect of cannibalization as well

Opportunity Cost • The cost of foregone alternative , especially useful in case of patents • Sunk Cost :Historical costs should not be considered,exapmle cost of survey done is historical cost

Separation of Investment and financing decisions • If there is debt financing and the interest rates are considered in cash flow then there will be double counting as in discount rate also the interest charges are added • Replacement decesion : Replacing and existing asset with a new one is also a decesion effecting cash flows

• Non cash elements such as deprecition,goodwill etc are not considered in project appraisal • Tax effect ; Plays a vital role in project appraisal

Distinguishing factors between domestic and international project appraisal • Blocked Funds • Effect of cash flows on other division • Restriction on Repatriation – – – – – – – –

Transfer pricing Royalities Leading and lagging Financing structure Inter company loans Currency of invoicing Reinvoicing centres Counter trade

Risk Factors • Social, Political and Economic risks effect the discount rate of the project hence in project appraisal the discount rate plays an important role.

Blocked funds • Money generated by a company's foreign operations that cannot be moved from one country to another because of one or more regulations in the country in which the money was generated. For example, a government may place a limit on the maximum amount that may be moved out of a country over a given period of time. Having an excessive amount in blocked funds may harm a company's cash flow.

Effect of cash flow on other divisions • If setting up a subsidiary impacts cash flow of other divisions then the net incremental cash flow is considered.

Restrictions on Repatriation • Transfer pricing : Refers to the policy of invoicing purchase and sale transactions between a parent company and its foreign subsidiary so that the are suitable for the parent company. • Royalities : The subsidiary company may pay royalities for the usage of parent company name and product

• Leading and Lagging : leading and lagging payment between parent company and subsidiary base on exchange rate forecast so that it is profitable for parent company. • Financing structure : An project can be funded on full equity, or debt of a combination. Where repatriation is difficult ,the parent company prefers giving loans so that repatriation of capital is easier.

• Currency of invoicing :Either a vehicle currency is opted for a more stable currency between parent and subsidiary,or between two subsidiaries is chosen to minimise exchange rate risks • Reinvoicing centres : Trades between companies in the same group can be routed through the reinvoiving centre,which is typically set in a tax haven

• Countertrade : Trade between parent and subsidiary can sometimes be as a barter,the parent company then selling it to thord party,thereby indirectly transferring profits of subsidiary

Risks and discount rates • • • •

Political Risk Economic Risk Exchange Rate risk Other Factors :• Inflation • Interest Rate • Market conditions

International Project Appraisal Techniques • NPV • Discounted cash flow analysis • APV

Risk adjusted discount rate • According to this approach different rates are used for different projects depending upon the nature of payments and risks involved. • Projects which have high risks are discounted at a higher the the average cost of capital ,wheresas projects with lower risks are discounted at lower risks

Different discounting rates • Ke =This rate should be the nominal discount rate for contractual •

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cash flows.As cash flows have been converted to the domestic currency ,it should be domestic nominal discount rate. Kd = Since the depreciation rate is on historical cost the discount rate should be nominal rate. Kb =Since the borrowing capacity would be measured in nominal ,this should be nominal rate Kc = As the nominal foreign currency interest rates would have to be paid in the absence of the concessionary loan,that rate should be used as the discount rate. Kp = There is a possibility of cash flows not being remitted,a risk is attached to it .

APV-Adjusted present value • Adjusted Present Value (APV) is a business valuation method. APV is the net present value of a project if financed solely by ownership equity plus the present value of all the benefits of financing. • APV = Unlevered NPV of Free Cash Flows and assumed Terminal Value + NPV of Interest Tax Shield and assumed Terminal Value

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Short term financial management • Features and key points of consideration – Investment of surplus – Short term borrowings – Currency Exposure – Tax management – Indian market , capital not opened up

Surplus Management • • • •

Least transaction cost-least bid-ask spread Liquidity Availability of investment vehicles Withholding taxes

• Objective – Maximize interest income – Minimize currency risk – Ensure sufficient liquidity

Selection of instrument • • • • •

Yield Marketability Exchange Rate risk Price risk Transaction cost

Financing short term deficits • Internal sources cheapest-centralized cash management beneficial • Overdrafts ,fixed term bank loans ,commercial paper etc. • Common problems-size and maturity mismatch

Centralized cash management • Economic • Improved working capital management through increased access to cash, resulting in reduced debt and increased return on investments of excess cash. • Reduced number of cash flows leading to improved management of liquidity. • Reduced number of bank s, which translates to lower transaction costs and bank fees.

• Control • Standardised cash management across all legal entities. • Global compliance with headquarters treasury policies and procedures, including SarbanesOxley (SOX) and Office of Foreign Assets Control (OFAC) requirements.

• Risk management • More effective management of FX exposures and interest rate risks through global oversight. • Netting of exposures leading to cost savings from fewer FX conversions and bank transfers. • Global view and management of limits on bank exposure.

• Scale economies • Increased productivity by leveraging centralisation of treasury activities and technology to achieve more output with fewer human resources. • Better process management through standardised key performance indicators (KPIs). • Transition to a centralised treasury is no easy task. Treasurers should keep in mind several critical success factors for a smooth transition:

• Scale economies • Increased productivity by leveraging centralisation of treasury activities and technology to achieve more output with fewer human resources. • Better process management through standardised key performance indicators (KPIs). • Transition to a centralised treasury is no easy task. Treasurers should keep in mind several critical success factors for a smooth transition:

• Executive management • Senior corporate management must sponsor the project to ensure sufficient resources for a successful transition. • Division, regional, and local senior management must also be on board to ensure coordination with corporate treasury to get the project done

• Executive management • Senior corporate management must sponsor the project to ensure sufficient resources for a successful transition. • Division, regional, and local senior management must also be on board to ensure coordination with corporate treasury to get the project done