project’s profitability. The reason is obvious – but for the investment abroad, additional
sales would not have been possible. ‘Synergy’ effect accordingly, should be reckoned.
Besides, care should be taken to include the true economic cost (i.e. opportunity cost) of
any resource required for the project, irrespective of the fact whether the firm owns the
resource or is to buy it from outside. For instance, rent foregone due to the use of
factory/office space (now to be used in the proposed investment project) is the relevant
cost.
It is often customary to charge investment projects with various items such as legal
counsel, technical know-how, management costs, research and development, training of
personnel, and so on. While these are costs from the point of view of project, they are
benefits (received in the form of fees and royalties) to the parent. Prima facie, they net
out each other and therefore, warrant exclusion. However, if such costs/overheads (or
some of them) are additional on account of the project, they form part of relevant cost
data. Clearly, the list of costs and benefits which ‘should be’ and which ‘should not be’
taken into account cannot be exhaustive; it may vary from one MNC to another in the
industry and may vary within the same MNC over a period of time. In carrying out an
‘incremental analysis’ exercise, the guideline is: but for the investment proposal under
consideration, these costs and benefits would not have taken place.
Both costs and benefits should be measured on a cash flow basis and not on the basis of
accounting profits. That cash flow approach is more useful and scientific as a decision
criterion than accounting profit approach, is well recognized in the literature of financial
management. The other reason under-lying superiority of cash flow approach are: (i) it
avoids the ambiguities of the accounting profit concept, (ii) it takes cognizance of the
time value of money. Above all, since investment analysis is concerned with finding out
whether future economic inflows are sufficiently large to warrant the initial investment,
only the cash flow method is appropriate for investment decision analysis.
In sum, it can be said that expected/projected incremental cash flows after taxes arising
out of the investment decision (of setting up a subsidiary abroad,
expansion/diversification of existing subsidiary) constitute the relevant data for its
evaluation.
While it is true that the principle of incremental analysis is very simple in terms of
conceptual framework, its practical appreciation is not without problems. For instance, it
is very difficult to estimate the magnitude of lost sales/accretion of sales on account of
the proposed project. However, it does not undermine the utility of ‘incremental
exercise’; it only cautions the executives responsible for such decisions.
- Evaluation of a project
Like domestic capital budgeting decisions, the objective of foreign capital budgeting
decisions by MNCs is maximization of the wealth of its shareholders. The technique of
net present value (NPV) is considered most appropriate in this regard as it is consistent
with the objective of financial decision to maximize the shareholders’ wealth.