Tài chính doanh nghiệp - Finance 407: Multinational financial management - Topic 15: Global capital budgeting and country risk

Topic #15: Global Capital Budgeting and Country RiskL. GattisThe Pennsylvania State University0Finance 407: Multinational Financial ManagementReview Poll: NPV1Caterpillar, Inc. is investing $100M to build a plant in Indiana and expects three years of annual EBIT of $25M, depreciation of $15M, CAPEX of $10M, and additions to working capital $5M. CAT’s tax rate is 40% and beta is 1.7. The risk free rate is 2% and the market risk premium is 5%. CAT’s credit spread on its debt is 4% and D/E ratio is 0.6. CAT estimates that the investment is worth 5 times FCF in year 4. What is the NPV of the investment? (Hint: Compute NPV for initial investment + the present value of 3 FCFs + the present value of the exit multiple valuation) Hints:CF(0)=-$100, CF(1)=25*(1-.4)+15-10-5=$15, D/(D+E)=.6/1.6 A. -$12M B. -$6M C. $0M D. +$6M E. +$12MReview Poll: NPV2Caterpillar, Inc. is investing $100M to build a plant in Indiana and expects three years of annual EBIT of $25M, depreciation of $15M, CAPEX of $10M, and additions to working capital $5M. CAT’s tax rate is 40% and beta is 1.7. The risk free rate is 2% and the market risk premium is 5%. CAT’s credit spread on its debt is 4% and D/E ratio is 0.6. CAT estimates that the investment is worth 5 times FCF in year 4. What is the NPV of the investment? (Hint: Compute NPV for initial investment + the present value of 3 FCFs + the present value of the exit multiple valuation) Hints:CF(0)=-$100, CF(1)=25*(1-.4)+15-10-5=$15, D/(D+E)=.6/1.6 A. -$12M B. -$6M C. $0M D. +$6M E. +$12MLearning Objectives3Students canvalue foreign investment using sovereign risk premiums, foreign proxies, and exchange rate forecast mitigate country riskNPV, WACC, and Risk4Same Business RiskSame LeverageCompute WACC using current values of the Firm’s E, D, Kd, and KeDifferent Capital Structure (Leverage)Steps:(1) Re-lever Firm’s beta (2) compute new debt spread (3) Compute new E, D, Kd, Ke, and WACC Different Business Risk (Incl. Country Risk)MethodsProxy Beta and Debt SpreadSRPFCF adjustmentsReview: Capital Budgeting Formulas5FCFF = EBIT*(1-Tc) + Deprec&Amort – CAPEX - ∆NWC Country Risk (a.k.a. Political Risk)6Country Risk is a term for the risk of operating in a foreign country. These risks include, but are not limited to:Currency crisisExpropriationLegal riskTrade Barriers (Tariffs, Quotas)Changes in regulationChanges in taxation (home or host)Inflation and Exchange rate riskEconomic crisisTerrorism, Violence, CrimeInfrastructure failures (power, transportation, communication, etc.) Global Risk Measure7AON Political Risk Map - 2010 Strategy to deal with differing country risk8Use a Sovereign Risk Premium (SRP) for a foreign investmentCompute the WACC for a domestic investmentAdd the sovereign risk premium for investment’s countrywhereSovereign Risk Premium9AAPL is launching a new venture in Brazil. The WACC for a similar venture is 8.85% in the U.S.. What is the WACC of the Brazilian project if the yield on Brazilian bonds is 12% and the yield on U.S. bonds is 3%?A. 9.97% B. 20.85% C. 11.85% D. 17.85% E. 9.00%Sovereign Risk Premium and Country Risk10Sovereign risk premiums are likely compensation for several risksDefault RiskInflation RiskExchange Rate risk (expected devaluation reflected in forward rates)Liquidity RiskSRPs are appropriate to the extent that they are good proxies for a project’s country riskForeign Expropriation and Taxes11Hershey is establishing a supply chain facility in Ghana. The project will cost $990M today and has a most likely free cash flow of $100M next year and then FCF will grow at 2% forever. The domestic project WACC is 9% and the sovereign risk premium is 3%. What is the NPV using the most likely cash flows and the sovereign risk premium? (Do not use the probability of expropriation)A. 0 B. -10 C. -$5 D.$5 E. $10Hershey estimates that there is a 33% chance of expropriation (or 100% taxation) in any year. What is the NPV using the expected cash flows (33% of zero, and 67% of most likely FCF of $100) and the domestic WACC?A. -$33 B. -$11 C. 0 D. $11 E. $33 An alternative way to think about the SRP is to compute the break-even (Zero NPV) probability of default.0=-990+100*(1-P)/(0.09-0.02); P=.307If you believe that the probability of total expropriation <.307, Accept Project12Currencies in Capital BudgetingConvert foreign cash flows into home currency before discounting using market forward rates or theoretical rates (PPP/IRP). Discount the cash flows using discount rate that account for the risk of the foreign cash flow riskProblem13Bayer Material Science division is considering an investment in Chile. The project would cost 100,000 Chilean pesos today and is expected to return 120,000 pesos in one year. The USD WACC for the Chilean investment is 15%. The spot price is 450 Peso/USD. Interest rates in the U.S. are 3% and interest rates in Chile are 7%. What is the USD NPV converting the peso FCFs to USD using the IRP exchange rate and discounting at the USD WACC?A. -$11 B. $1 C. $111 D. +$11 E. -$111NPV, WACC, and Risk14Same Business RiskSame LeverageCompute WACC using current values of the Firm’s E, D, Kd, and KeDifferent Capital Structure (Leverage)(1) Re-lever Firm’s beta (2) compute new debt spread (3) Compute new E, D, Kd, Ke, and WACC Different Business Risk (and Global)MethodsProxy Beta and Debt SpreadSRPFCF adjustmentsManaging Country Risk During Capital Budgeting15 Account for country risk in NPV – cashflows or discount rate – to ensure compensation for risk Diversify across nations and regions Avoid/Delay Investments if environment too risky Obtain Federal Insurance: OPIC (Overseas Private Investment Corp)Managing Country Risk During Financing16Structure the investment to minimize exposureObtain outside financing: World Bank, Regional Development Bank, IMF, Foreign Government, Foreign BankPartners, Joint Ventures, LicensingProject FinanceMinimize/delay own financingFinance foreign projects using foreign denominated debt. If foreign currency devalues, falling US$ price of foreign assets is offset by falling liability values and US$ financing costs.Managing Country Risk During Operations17Function Currency = Local Currency (Translation Exposure)Managing balance sheetDevelop local stakeholdersLocal banks, employees, suppliers, etc.Maximize reliance/dependence on firmTax Arbitrage (subsidiary-subsidiary, and parent-subsidiary)Transfer pricing, retain profits abroad, disguise profits, transfer profits, Use DerivativesiClicker: Class EvaluationHow would you rate today’s class? Highest Lowest18Assigned Problems19Suppose the yields on government bonds in the U.S., Mexico, and Pakistan are 4%, 7%, and 9%. A U.S. multinational firm is considering an investment in Mexico or Pakistan. The domestic discount rate is 12%. What are the discount rates for Mexico and Pakistan using the sovereign risk premium method? Mexico Cost of Capital = .12 + (.07-.04)=.15 Pakistan Cost of Capital = .12 + (.09-.04)=.17Exxon Mobil (XOM) is considering building a refinery in Mexico. The project would cost $100M dollars today and return free cash flows of $120M in one year. XOMs stock beta is 1.3. The U.S. risk free rate is 2% and the market risk premium is assumed to be 6%. XOM’s D/E ratio for XOM’s existing business and this project is .3 and its tax rate is 35%. The credit spreads for XOM debt is 4%. XOM will adjust for country risk by applying a sovereign risk spread to its domestic WACC. Mexico’s risk free rate is 9%. What is the NPV of the project? Mexico WACC=(1/1.3)*(.02+1.3*.06)+(.3/1.3)*(.02+.04)*(1-.35)+(.09-.02)=15.4% NPV =-100+120/(1.154)=$3.9MStarting with the last problem. Now assume the XOM will finance this project differently than the existing business. The new project has a tax rate of 40% and D/E will be .6 and this will increase the domestic debt credit spread by 3% (300 basis points). What is the NPV (with sovereign risk premium) using the projects capital structure? Hint: de-lever XOM’s beta and re-lever for the investment.Unlevered XOM beta: 1.3/(1+.3*(1-.35))=1.088 Levered investment beta = 1.088*(1+.6*(1-.4))=1.48 WACC =(1/1.6)*(.02+1.48*.06)+(.6/1.6)*(.02+.04+.03)*(1-.4)+(.09-.02)=15.8% NPV =-100+120/(1.158)=$3.63MAssigned Problems20Caterpillar is investing $100M to build a plant in India and expects three years of annual EBIT of $25M, depreciation of $15M, CAPEX of $10M, and additions to working capital $5M. CAT’s tax rate is 40% and beta is 1.7. The risk free rate is 2% and the market risk premium is 5%. CAT’s credit spread on its debt is 4%. CAT’s D/E ratio is .6. CAT estimates that the investment is worth 5 times FCF in year 4. The sovereign risk premium for India is 7%. What is the NPV of the investment? (Hint: Compute NPV for initial investment + 4 year) FCF=25*(1-.4)+15-10-5=15 K=(1/1.6)*(.02+1.7*.05)+(.6/1.6)*(.02+.04)*(1-.4)+.07=14.91% NPV=-100+15/1.1491+15/1.1491^2+15/1.1491^3+(15*5)/1.1491^4=-23M