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International Capital Budgeting: Valuing Foreign Subsidiaries, M&A Financing, Capital Structure, and

Appropriate discount rate for valuing foreign subsidiary cash flows


1.  What is the appropriate discount rate to use in valuing cash flows from a foreign subsidiary?

?The WACC of the parent company/ home country

2.   What are the main ways that a merger/acquisition is financed?  Which one is best?
?Debt Acquisition
?IPO (initial public offering)
?Issue bonds
?Exchange stocks
It depends on the company’s capital structure and the cash available.

3.  What are the relevant cash flows to include in your international capital budget to evaluate the choice of IFC-France to invest in the frozen food manufacturing (or Repuestos to invest in Argentina) or not?

Income, variable costs, expenses, depreciation, maintenance, taxes, royalties, initial investment, tax on depreciation, cannibalization of exports/profits, tax credits.


4.  What would be the optimal capital structure for a company such as Uber just before the time of their IPO?  Why?

Depends. Some debt is good to use as a tax shield but too much debt is bankruptcy risk liability.


5.  How is depreciation treated in international capital budgeting?

Capital budgeting analysis uses only actual cash inflow and outgo specific to a project. Depreciation is a non-cash expense but the extent that its deductible from taxable income improves the cash flow stream (i.e. lessens income taxes) must be considered - estimated yearly as:

[((c - v)/y) x t)]  
c = total cost of asset
v = estimated salvage value, end-of-life
y = years life of asset
t = income tax rate

Depreciation is an important concept in capital budgeting. This is because it is a non cash expense and ideally should not have any effect on the cash flows. This is the reason why it is added back during cash flow calculations. Since the amount of depreciation never actually left our bank account in the form of expenses, we still have it in cash. First, we deducted it while calculating the net income in the income statement. Then we added the same amount back while calculating cash flows, thus nullifying its effect.    
Yagana (have to double check though)

6.  What should the South African internet and media company, Naspers, do with its 10% stake in Tencent?  This investment back in 2001 has accounted for more than ¾ of Naspers’ earnings in the past five years.

Depends. They could sell the investment if they can reinvest with a higher return. Stick to their competitive advantage.


7.  What would be the value of after-tax funds brought back to the US from a French subsidiary, if the subsidiary earned €100 million last year, remitted all of the profits, and had no other foreign operations?

French corporate tax rate: 34%
US corporate tax rate: 26%
French tax on dividend remittances to non-resident foreigners: 30%
French value added tax (VAT) on sales: 12%
Price of tea in China: RMB 6/kilo

8.  What could the US company do to reduce the overall tax burden (without cheating!) in the example above (Q7)?  Identify 2 strategies.

Value added tax is deductible before you add do not get credit for this (tax on income can be only credited) wealth/property/sales tax value added you do not get credit tax for.
How could you reduce your overall tax credit in some way: do not bring back the income to the US: and it helps with dividends remittances. If you make your Shareholders happy bcoz you made money and did not bring it but you are reinvesting it in France so your shareholders will still be happy.
If you operate in other countries and have taxes due in the US, you can use this tax credit to use it if you have other taxes due in other countries to pay that off.
You set up a subsidiary in other country, you take your profit after taxes and pay the remittances taxes, you paid both taxes, you charge a royalty at subsidiary in X country for management fee, technology, export/imports – just make it sound like you have another expense and you raise the cost side of the equation on the finances and save at the end.

Yagana (from class notes -- will edit later tonight)

9.  Knowing what you now know about capital structure, what was the best choice for Facebook to finance its project to create a more user-friendly interface, which was expected to take 2 years, when they needed $500 million and they were operating as a publicly-traded company already for 5 years?  Why?

10. What is the one factor to which an NPV of a capital budgeting project is most sensitive?  That is, if this factor changes, it has the most impact on the value of the NPV.

11.  In the Repuestos case, what key factors had to be included in the calculations in year 0 (before manufacturing started in Argentina) and after year 5?  Name at least 3 key factors.

12.  What are three additional methods, beyond NPV analysis, that can be used to evaluate companies for mergers or acquisition?

Comparable Company Analysis (Public Comps): Evaluating other, similar companies’ current valuation metrics, determined by market prices, and applying them to the company being valued.

Precedent Transaction Analysis (M&A Comps): Looking at historical prices for completed M&A transactions involving similar companies to get a range of valuation multiples. This analysis attempts to arrive at a “control premium” paid by an acquirer to have control of the business.

Leverage Buyout/“Ability to Pay” Analysis (LBO): Valuing a company by assuming the acquisition of the company via a leveraged  buyout, which uses a significant amount of borrowed funds to fund the purchase, and assuming a required rate of return for the purchasing entity.

13.  What are the two key issues/concerns about using debt in a company’s capital structure?

1.Bankruptcy risk

14. If GE wants to sell its oil & gas equipment manufacturing division, what are three means for carrying out this sale?  Which one would probably work best, and why?

15. What are the 3 justifiable reasons for undertaking (or at least considering) an acquisition, despite the fact that ¾ of them do not add value to the acquiring company?

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