How do we approach an international investment?

   We have seen so many mergers and acquisitions involving companies from two different regions coming together. Especially in India where we are seeing a huge flow of investments, one would always wonder how someone sitting thousands of miles away make an investment decisions does. In our article today we look at how companies approach this, the article is helpful for the people who are curious and also the students who have opted for AFM paper.

 

Following are the points which need to be considered while approaching international investment appraisal.

 

1. While dealing with the international investment appraisal question, we have to have to solve it in a disciplined manner. There should be a proper format to be followed with the working notes for every points. We should also mention an assumption considered while solving the questions.
2. As we are dealing with the international investment appraisal question, there will be multiple currencies involved. We need to understand from the question what is base currency, trading currency and what is asked in the question.
3. On the basis of information available in the question, we will have to calculate conversion rates with the help of inflation rates in two different currencies. Eg. If company is based in US and has USD as base currency and dealing with UK client. Then we will have to calculate conversion rates from UK to USD with the help of inflation rates. This can be calculated as follows

Foreign currency * (1+ Inflation rate of foreign country)/(1+ inflation rate of base currency)

4. In some cases, we might get cash inflow 6 monthly instead of yearly cash flow. That time we will have to calculate conversion rate on the basis of average of two years’ rate.
5. There are two ways to solve the question. One way is we will consider inflation impact and covert the cash flows in nominal terms and then discount it by nominal rate. Another way is to keep it in real terms.

 

Nominal discounting rate = (1+r)*(1+h)

 

6. Then we will have to understand the cash flows of investment phase and cash flows of return phase. We will also have to understand whether it is real or nominal terms.
7. One of the important factor which has major impact on international investment appraisal is taxation. Company might be earning income in one country and then repatriating to home country. There can be different scenarios for this. When repatriating project cash flows to home country, i) if corporate tax rate in foreign country is more than home country, then no need to pay tax on repatriated cash flows. Ii) If tax rate is same in both the countries no need of extra payment of the tax in home country. Iii) if Corporate tax rate in home country is more than the foreign country, then additional tax will be paid in the home country. We also have to understand from the question whether tax is paid in the year of income earned or it is differed. This depends on the political and economic situation in two countries might be different.
8. If any payment is made by subsidiary company to home currency in a way of management fees or HO expenses or repayment of any loan etc., then in that case tax will be applicable in the home country of HO as it is income of HO irrespective of the tax rate in the foreign country.
9. While working for the project, if company has undergone major structural change or if company has got some grants or subsidised loans, then instead of calculating NPV, adjusted NPV will be better as it will consider financial side effects separately. It is calculated in two steps.

1. Base NPV is calculated with the help for ungeared cost of equity assuming that debt has zero risk.
2. Then financial side effects will be calculated. This includes present value of tax relief on the interest payment, present value of cost of issue, PV of benefit of subsidy received.

10. One more important thing is embedded option in the project. If we calculate the conventional NPV, then we will ignore the option available in the proposal. Eg. In the technical article question, if we work on the initial project of Enat then we will also get the further proposal for big tram network. This extension option is only available if company satisfactorily deliver the initial project. With the help of BSOP model, we can calculate the value of option available in the original proposal to get the actual value of the proposal.

 

So as can be seen the process of conducting an investment appraisal which involves international investments can be pretty difficult to one to crack however in times of today where the globalisation is reaching new heights, knowing the steps above can definitely help you make a right decision.