IBUS 401 TEST 3 QUESTIONS &
ANSWERS
Forms of political risk - ANSWER - government takeover
- attitude of consumers
- actions of host government
- blockage of fund transfers
- currency inconvertibility
- wra
- inefficient bureaucracy
- corruption
Steps involved in assessing country risk - ANSWER - First, the political factors are
assigned values within some arbitrary chosen range (such as 1-5, where 5 is lowest risk
and thus best value)
- Next, political factors are assigned weights (representing degree of importance), which
should add up to 100%. The assigned values of the factors multiplied by their respective
weights can then be summed to derive a political risk rating
- Process is then repeated to derive financial risk rating.
- Once the political and financial ratings have been derived, a country's overall risk
rating as it relates to a specific project can be determined by assigning weights to the
overall political and financial ratings according to their importance (sum to 100)
How could a country risk assessment be used to adjust a project's required rate of
return? - ANSWER The discount rate of a proposed project is supposed to reflect the
required rate of return on that project. Thus, the discount rate can be adjusted to
account for the country risk. The lower the country risk rating, the higher the perceived
risk and the higher the discount rate applied to the project's cash flows.
How could a country risk assessment be used to adjust a project's estimated cash
flows? - ANSWER Perhaps the most appropriate method for incorporating forms of
country risk in a capital budgeting analysis is to estimate how the cash flows would be
affected be each form of country risk. For example, if there is a 20% probability that the
host government will temporarily block funds from the subsidiary to the parent, the MNC
should estimate the project's NPV under these circumstances, realizing that there is a
20% change that this NPV will occur. Each possible form of risk has an estimated effect
on the foreign project's cash flows and therefore on the project's NPV. By analyzing
each possible effect, the MNC can determine the probability distribution of NPVs for the
project.
Capitalizing on low-cost labor - ANSWER Labor and land costs can vary dramatically
among countries. Multinational corporations often attempt to set up production in
locations where land and labor are cheap. Because of market imperfections such
imperfect information, relocation transaction costs, and barriers to industry entry,
, specific labor costs are seldom equal among markets. Thus, it is worthwhile for MNC's
to survey markets to determine whether they can benefit from cheaper costs by
producing in those markets.
Host government incentives for DFI - ANSWER In some cases, a government will offer
incentives to MNCs that consider DFI in its country. Governments are particularly willing
to offer incentives for DFI that will result in the employment of local citizens or an
increase in technology. Common incentives offered by the host government include tax
breaks or the income earned there, rent-free land and buildings, low-interest loans,
subsidized energy, and reduced environmental regulations. The extent to which a
government will offer such incentives depends on how much it benefits from the MNC's
DFI
Why should capital budgeting for subsidiary projects be assessed from the parent's
perspective? - ANSWER Normally, multinational capital budgeting should be based on
the parent's perspective. Some projects might be feasible for a subsidiary but not
feasible for the parent, since net after-tax cash inflows to the subsidiary can differ
substantially from those to the parent. Such differences in cash flows between the
subsidiary versus parent can be due to several factors
Using the capital budgeting framework, explain the sources of uncertainty surrounding a
proposed project in Hungary by a US firm, how is that different than in a more
developed European country - ANSWER - Exchange rate fluctuations
- inflation
- financing arrangement (parent vs. subsidiary financing of the project)
- blocked funds by the host government
- uncertain salvage value
- impact of project on prevailing cash flows
- host government incentives
- real options
Impact of exchange rates on NPV - ANSWER From the parent's point of view, an
appreciation of the Singapore dollar would be favorable because the earnings received
by the subsidiary and remitted to he parent would be converted to more US dollars.
Conversely, a depreciation would be unfavorable because the earnings received by the
subsidiary and remitted to the parent would be converted to fewer US dollars
- subsidiary manufactures and sells locally
Target's local political conditions - ANSWER Potential targets in countries where
political conditions are favorable are less likely to experience adverse shocks to their
cash flows. If a MNC plans to improve the efficiency of a target by laying off employees
who are no needed, it must first make sure that the government would allow layoffs
before it makes the acquisition. Some countries protect employees from layoffs, which
may cause many local firms to be inefficient. A MNC might not be capable of improving
efficiency if it is not allowed to lay off employees
ANSWERS
Forms of political risk - ANSWER - government takeover
- attitude of consumers
- actions of host government
- blockage of fund transfers
- currency inconvertibility
- wra
- inefficient bureaucracy
- corruption
Steps involved in assessing country risk - ANSWER - First, the political factors are
assigned values within some arbitrary chosen range (such as 1-5, where 5 is lowest risk
and thus best value)
- Next, political factors are assigned weights (representing degree of importance), which
should add up to 100%. The assigned values of the factors multiplied by their respective
weights can then be summed to derive a political risk rating
- Process is then repeated to derive financial risk rating.
- Once the political and financial ratings have been derived, a country's overall risk
rating as it relates to a specific project can be determined by assigning weights to the
overall political and financial ratings according to their importance (sum to 100)
How could a country risk assessment be used to adjust a project's required rate of
return? - ANSWER The discount rate of a proposed project is supposed to reflect the
required rate of return on that project. Thus, the discount rate can be adjusted to
account for the country risk. The lower the country risk rating, the higher the perceived
risk and the higher the discount rate applied to the project's cash flows.
How could a country risk assessment be used to adjust a project's estimated cash
flows? - ANSWER Perhaps the most appropriate method for incorporating forms of
country risk in a capital budgeting analysis is to estimate how the cash flows would be
affected be each form of country risk. For example, if there is a 20% probability that the
host government will temporarily block funds from the subsidiary to the parent, the MNC
should estimate the project's NPV under these circumstances, realizing that there is a
20% change that this NPV will occur. Each possible form of risk has an estimated effect
on the foreign project's cash flows and therefore on the project's NPV. By analyzing
each possible effect, the MNC can determine the probability distribution of NPVs for the
project.
Capitalizing on low-cost labor - ANSWER Labor and land costs can vary dramatically
among countries. Multinational corporations often attempt to set up production in
locations where land and labor are cheap. Because of market imperfections such
imperfect information, relocation transaction costs, and barriers to industry entry,
, specific labor costs are seldom equal among markets. Thus, it is worthwhile for MNC's
to survey markets to determine whether they can benefit from cheaper costs by
producing in those markets.
Host government incentives for DFI - ANSWER In some cases, a government will offer
incentives to MNCs that consider DFI in its country. Governments are particularly willing
to offer incentives for DFI that will result in the employment of local citizens or an
increase in technology. Common incentives offered by the host government include tax
breaks or the income earned there, rent-free land and buildings, low-interest loans,
subsidized energy, and reduced environmental regulations. The extent to which a
government will offer such incentives depends on how much it benefits from the MNC's
DFI
Why should capital budgeting for subsidiary projects be assessed from the parent's
perspective? - ANSWER Normally, multinational capital budgeting should be based on
the parent's perspective. Some projects might be feasible for a subsidiary but not
feasible for the parent, since net after-tax cash inflows to the subsidiary can differ
substantially from those to the parent. Such differences in cash flows between the
subsidiary versus parent can be due to several factors
Using the capital budgeting framework, explain the sources of uncertainty surrounding a
proposed project in Hungary by a US firm, how is that different than in a more
developed European country - ANSWER - Exchange rate fluctuations
- inflation
- financing arrangement (parent vs. subsidiary financing of the project)
- blocked funds by the host government
- uncertain salvage value
- impact of project on prevailing cash flows
- host government incentives
- real options
Impact of exchange rates on NPV - ANSWER From the parent's point of view, an
appreciation of the Singapore dollar would be favorable because the earnings received
by the subsidiary and remitted to he parent would be converted to more US dollars.
Conversely, a depreciation would be unfavorable because the earnings received by the
subsidiary and remitted to the parent would be converted to fewer US dollars
- subsidiary manufactures and sells locally
Target's local political conditions - ANSWER Potential targets in countries where
political conditions are favorable are less likely to experience adverse shocks to their
cash flows. If a MNC plans to improve the efficiency of a target by laying off employees
who are no needed, it must first make sure that the government would allow layoffs
before it makes the acquisition. Some countries protect employees from layoffs, which
may cause many local firms to be inefficient. A MNC might not be capable of improving
efficiency if it is not allowed to lay off employees
