The basic principles of capital budgeting are valid for both domestic and multin

Question

The basic principles of capital budgeting are valid for both domestic and multinational capital budgeting analysis. However, it is important to recognize the unique risks that multinational firms face when they perform capital budgeting analysis in a foreign market. For instance, a U.S.-based multinational firm might conduct business in Brazil, but any profits made must be repatriated, or returned, to the parent company and converted to U.S. dollars. There are significant risks inherent in these rather simple operations. In the table below, correctly identify whether each type of risk being described is an exchange-rate risk or a political risk. The uncertainty associated with the value of cash flows generated in one currency and then converted to another The risk of higher than expected taxes, tighter repatriation, or currency controls by the host country The risk of expropriation (seizure) of a foreign subsidiary's assets by the host country or restrictions on cash flows to the parent company Price Industries has considerable operations in Indonesia, producing component electronic parts. Price's Indonesian operation has been very successful, but the firm is now concerned about the effect of the decline in the value of the Indonesian rupiah on the firm's profits. Which type of multinational capital budgeting risk is being illustrated by Price's situation? Market risk Exchange-rate risk Corporate risk Political risk Stand-alone risk Firms may take steps to reduce the risk of investing in foreign countries. Identify whether each of the following statements are true or false. A tool to lower the risk of multinational capital budgeting is to purchase insurance against the loss from expropriation of funds. Generally, the political risk related to foreign investment is not added to the required rate of return. A technique to lower the risk of multinational capital budgeting is to finance the foreign subsidiary with capital raised in the host country. A technique to lower the risk of multinational capital budgeting is to finance the foreign subsidiary with capital raised in a country in which the asset is not located.

Explanation / Answer

1. Exchange rate risk

2. Political risk

3. Political risk

4. Price industries is facing Exchange rate risk

5. True

6. True

7. True

8. False

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