Introduction to Corporate Finance

17: International Investment Decisions

1 Explain how a rise in the euro might affect a French company exporting wine to Australia, and

compare that with the impact on a German company importing gold from Australia.

2 Holding all other factors constant, how might an increase in interest rates in the UK affect the value

of the pound?

3 If someone says, ‘The exchange rate between dollars and pounds increased today,’ can you know

with certainty which currency appreciated and which depreciated? Why or why not?

4 Define spot and forward exchange rates. If a trader expects to buy a foreign currency in one month,

can you explain why the trader might prefer to enter into a forward contract today, rather than

simply wait a month and transact at the spot rate prevailing then?

CONCEPT REVIEW QUESTIONS 17-1

17-2 LONG-TERM INVESTMENT

DECISIONS

In chapters 9 to 11, we emphasised the importance of sound capital budgeting practices for a corporation’s

long-term survival. The same lessons covered in those chapters apply to multinational corporations.

Whether investing at home or abroad, MNCs should evaluate investments based on their incremental

cash flows, and should discount those cash flows at a rate that is appropriate given the risk of the

investment. However, when a company makes investments denominated in many different currencies,

this process becomes a bit more complicated. First, in what currency should the company express a

foreign project’s cash flows? Second, how does one calculate the cost of capital for an MNC, or for a

given project?

17-2a CAPITAL BUDGETING

Suppose that an Australian company is weighing an investment that will generate cash flow in euros. The

company’s financial analysts have estimated the project’s cash flows in euros as follows:

Initial cost Year 1 Year 2 Year 3

• €2 million €900,000 €850,000 €800,000

To calculate the project’s NPV, the Australian company can take either of two approaches. First,

it can discount euro-denominated cash flows using a euro-based cost of capital. Having done this, the

company can then convert the resulting NPV back to dollars at the spot rate. For example, assume that

the risk-free rate in Europe is 5%, and the company estimates that the cost of capital (expressed as a euro

rate) for this project is 10% (in other words, there is a 5% risk premium associated with the investment).

The NPV, rounded to the nearest thousand euros, equals €122,000:

NPV ,,

,

.

,

.

,

.

2 000 000 ,

900000

110

850000

110

800000

110

=− ++ 12 += 3 121713

LO 17.2

Ike Mathur, University

of Southern Illinois at

Carbondale

‘What I find very

interesting is that for a

long time in international

finance we have talked

about the first mover

advantage.’

See the entire interview on

the CourseMate website.

Source: Cengage Learning

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