Other significant factors, not present in this case but nevertheless important from
an overall point of view in considering foreign capital investments are:
- Foreign exchange rate forecast.A long forecast of future foreign exchange rates
is necessary, and various predictions are possible. - Income grossed up for parent country taxation.In the present case in which the
Brazilian corporate income tax rate is 40% and the U.S. rate is only 34%, no
grossed-up calculation is needed. No additional U.S. income tax liabilities are
incurred on dividends from Brazil.
In many instances, however, parent overall cash flow may be influenced by how
the project interacts with other international ventures. Under present U.S. tax law
(which could be changed), dividends from operations in countries where the income
tax rate is above the U.S. tax rate generate “excess” (i.e., lost) tax credits. These ex-
cess tax credits can be used only if dividends of a similar nature are declared from
other subsidiaries operating in jurisdictions where the tax rate is below the U.S. tax
rate. Thus the high taxes of one foreign jurisdiction can be combined with the low
taxes of another foreign jurisdiction to minimize overall total U.S. taxes levied on the
total post-tax dividends received from all foreign countries.^3
Because the negative net present value of US$1,567,000 is comparatively small,
relative to the overall size of the project, management’s task might be to seek out
some other combination of investment costs (perhaps subcontracting part of produc-
tion), revenue (perhaps raising sales prices in some markets), or operating costs (per-
haps using a different degree of technology or automation to reduce costs) that will
generate a positive net present value. Another possibility would be to increase the
transfer price on items sold by the U.S. parent to Cacau do Brazil.
Any such steps would have cash flow consequences for Cacau do Brazil as well as
its U.S. parent. However a finance manager should be a “doer” rather than just a pas-
sive analyst of data collected from others, so the finance manager should participate
actively in the search for another combination of cash flows that would lead to ex-
pected positive net present values for both project and parent.
Management might also decide to go ahead, in spite of the calculated negative net
present value, for reasons of global strategy. One way of expressing this in financial
terms is to acknowledge that some long-run global advantage can be achieved with
the Brazilian subsidiary that can not be quantified as estimated cash flows. Some will
argue that the introduction of such subjectivity destroys the rigor of the net present
value approach to capital budgeting. Others will argue that recognition of long-run
nonquantifiable strategic goals is an important part of management’s judgment and
hence is vital to success. The latter will say one should not be a slave to a quantita-
tive approach, but should use it only as a valuable guide.
(^3) For a detailed explanation of this pooling of tax credits, see pp. 497–501 of David K. Eiteman, Arthur
I. Stonehill, and Michael H. Moffett, Multinational Business Finance, 9th ed. Boston: Addison-Wesley-
Longman, 2001.
APPENDIX A 4 • 19