dure, under which both assets and debts are increased by the present value of a fi-
nancial lease, will change the apparent cash outflow (amount of assets required) with-
out any real change being needed. Amortization of a financial lease obligation may
also vary from a strict measurement of the cash needed for lease payments. An
awareness of such variations is essential.
(d) Other
(i) Changes in Accounting Principles and Methods Without Prior Year Change. Many
countries switch from one accounting principle to another, say, from one type of de-
preciation assumption to another, without adjusting financial statements for the prior
year. Under these conditions, measures of both income and cash flow from one year
to another are not meaningful. Because depreciation is a noncash expense which is
often added back to obtain cash flow, as in the bottom-up example given earlier, and
because income taxes paid depend in part on the depreciation approach used, a
change in depreciation method in future years may have cash flow implications. If the
change is made to augment (“dress up”) reported income, the cash flow implication
may be negative because of the tax impact.
(ii) Treatment of Unconsolidated Subsidiaries. Unconsolidated subsidiaries are
recorded differently in different countries. In some countries, unconsolidated sub-
sidiaries are carried at original historical cost (rather than at equity, as in the United
States). Hence, earnings of the foreign subsidiary are reported only when received as
dividends, rather than when earned. Retained earnings in the subsidiaries, and thus
subsidiary cash flow less cash dividends, are concealed. This has two consequences:
(1) some cash flow from a consolidated perspective is kept secret, and (2) variations
in dividend payments from nonconsolidated subsidiaries can be used to conceal vari-
ations in earnings and/or cash flow in the parent entity. In periods when the parent
entity itself has abnormally low earnings, dividends from subsidiaries may be used
to bolster reported earnings.
The 2001–2002 scandal at Enron Corporation in the United States was a separate
type of misstatement. Nonconsolidated subsidiaries were written up, creating a non-
realized increase in earnings that was used to justify pumped-up stock prices.
(iii) Blocked Funds. If cash flow in the host country is blocked so that it is not avail-
able for dividends and consequently for reinvestment elsewhere in the world system,
the value of that cash flow in a capital budgeting context can be questioned. Although
no treatment can necessarily be considered “correct,” often blocked cash is valued as
if it were reinvested in the local economy at a nominal risk-free rate and then repa-
triated at a much later date. If repatriation of blocked cash flows is not expected,
those funds should have no value in the capital budgeting analysis.
4.5 SUMMARY International investment analysis is based on analysis of expected
future cash flows from a foreign direct investment. The database for estimating fu-
ture cash flows is often current and recent past financial statements. In addition, fu-
ture cash flows depend on local accounting and tax treatment of profits and expenses.
The essential difference between domestic and international investment analysis is
that estimates of future cash flows are in different currencies and depend on local ac-
counting methods. Those methods often differ from one country to another.
4 • 10 FOREIGN INVESTMENT ANALYSIS