with direct (as distinct from portfolio) investments. Examples range from purchase
of new equipment to replace existing equipment, to an investment in an entirely new
business venture in a country where, typically, manufacturing or assembly has not
previously been done. The technique is also useful for decisions to disinvest, that is,
liquidate or simply walk away from an existing foreign investment.
The overall foreign investment decision has two components: the quantitative
analysis of available data (“capital budgeting” proper) and the decision to invest
abroad as part of the firm’s strategic plans. Investments of sufficient size as to be im-
portant are usually conceived initially because they fit into a firm’s strategic plan. The
quantitative analysis which follows is usually done to determine if implementation of
the strategic plan is financially feasible or desirable.
This chapter deals with the quantitative aspects of foreign investment analysis. It
treats, first, the general methodology of capital budgeting, second, the international
complexities of that procedure, and third, the implications of international account-
ing for conclusions reached by that methodology. For convenience, the United States
will be regarded as “home.” However, the principles discussed have relevance for
any home company investing in a foreign land.
An example of the foreign capital budgeting process appears in Appendix A to il-
lustrate how an international project might be evaluated.
4.2 GENERAL METHODOLOGY FOR ONE-COUNTRY CAPITAL BUDGETING. Cap-
ital budgeting is essentially concerned with three types of data: (1) cash outflows
(i.e., project costs) and (2) project cash inflows, both of which are measured over a
period of time, and (3) the marginal cost of capital. This chapter will follow the typ-
ical procedure of using annual time periods, but an analysis could be based on cash
flows for quarters, months, or even days.
(a) Project Cash Outflows (Costs). Project cash outflows refers to the cashcost paid
out to start the project. Usually the outflow for an investment occurs at the time when
the investment is made, which is to say in “year 0” if the project is to be analyzed in
annual time periods. However, other time squences are possible; for example, the
cash outlay could occur over several years, as when a very large hydroelectric plant
is being constructed.
Cash outflows include:
- Cash paid for all new assets purchased.
- Cash paid to prepare a new site. These outlays might be for such costs as grad-
ing, building access roads, or installing utilities. - Cash paid to dispose of, remove, or destroy old equipment or other assets, or, al-
ternatively, net cash received from the sale of old assets. Cash disbursed or re-
ceived, net of any tax effect, is the relevant flow. - Cash cost of additional storage and/or transportation facilities needed because of
the new investment. If the new venture necessitates additional warehousing
space or additional transportation equipment (e.g., a new fleet of trucks), these
additional costs must be included as part of the required supporting investment
for the project.
4 • 2 FOREIGN INVESTMENT ANALYSIS