Quiz 15: International Capital Budgeting

Business

The dividends that will occur more than 10 years in the future is the terminal dividend value representing the discounted present value of all expected future dividends in years 11 and beyond into the indefinite future. It can be calculated in two steps. Step 1: The terminal value of dividend in year 10 is taken as perpetuity that is growing at 2 % img with the long term euro inflation rate. The value of dividend in year 11 will be 2 % higher than the expected value of dividend in year 10 img . With the discount rate img the terminal value of dividend in year 10 img is given by: img Substitute the values in the formula: img The terminal value of dividend in year 10 is 258.25 million. Step 2: Now the terminal value in year 10 img is discounted to year 0 to get the present value of terminal value img as given below: img Substitute the values in the formula: img The terminal value is 90.29 million. The adjusted net present value of IWPI-Spain is € 134.26 million. The dividends that will occur more than 10 years in the future; the terminal dividend is € 90.14 million. So the percentage of the adjusted net present value of IWPI-Spain project arises from the dividends that will occur more than 10 years in the future is: img The percentage of adjusted net present value is 67.13%

Many countries have restrictions on the amount of cash flows that can be sent back to the parent corporation from its foreign subsidiary. Apart from such regulation, there are many other factors such as taxes and foreign controls that limit the amount of funds to be transferred from the foreign subsidiary to the parent corporation. Thus, the investment project that is valuable for the foreign subsidiary when evaluated as a stand-alone firm can be less valuable for the parent corporation. The investment project's net after tax cash flows to the foreign subsidiary are different from those to the parent corporation. The parent corporation does not receive all of the investment project cash flows which are received by the foreign subsidiary. In fact, foreign subsidiary pay royalty, licensing agreements and overhead management fees to the parent corporation. As a result, there are differences in cash flows (generated by the investment project) to the foreign subsidiary and the parent corporation. So, an investment project that produces a positive net present value for the foreign subsidiary may have a negative net present value for the parent corporation. Therefore, an investment project of a foreign subsidiary that has a positive net present value when evaluated as a stand-alone firm can be rejected by the parent corporation.

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