International Financial Management

In 2016 Siemens, the German company known for its expertise in electrical engineering and electronics, had 114,000 employees in Germany and 234,000 employees outside of Germany. If its Brazilian subsidiary would like to expand its operations in anticipation of growth throughout Latin America, someone in German headquarters must decide whether the projected benefits outweigh the costs. Will the analysis be done in euros or Brazilian reais? Will it matter? This chapter addresses such questions.

International capital budgeting can be done in two basic ways: either by forecasting future foreign currency cash flows and then discounting them with a foreign currency discount rate, or by converting the foreign currency cash flows into forecasts denominated in the domestic currency and then discounting them with a domestic currency discount rate. The two values should be the same when expressed in a common currency. However, that doesn't always happen in practice unless the two methods are used with the same implicit assumptions. The chapter considers an international capital budgeting case that demonstrates how easy it is to get different values with the two methods for discounting foreign currency cash flows and what assumptions are required to ensure that the methods are equivalent.

The chapter also discusses several important topics that extend and complement the basic international capital budgeting analysis presented in Chapter 15. In that chapter, we developed a framework for international capital budgeting using adjusted net present value (ANPV) analysis. In this chapter, we consider two alternative approaches. First, we discuss how to value a project using the weighted average cost of capital (WACC) approach to capital budgeting. Then we examine the flow-to-equity (FTE) approach to capital budgeting, which is a third way of valuing projects. We discuss situations in which firms might prefer to use WACC or FTE, we explore the limitations of the different approaches, and we determine when a WACC or an FTE analysis is equivalent to an ANPV analysis.

It is well known that valuations often hinge on assumptions about terminal values. We examine the appropriate terminal value of a firm if we assume that current expansion of the firm and future competition drive the return on investment equal to the cost of capital into the indefinite future.