Multinational capital budgeting

The basic principles of capital budgeting are valid for both domestic and multinational capital budgeting analysis. However, it is important to recognize the unique risks that multinational firms face when they perform capital budgeting analysis in a foreign market. For instance, a U.S.-based multinational firm might conduct business in Brazil, but any profits made must be repatriated, or returned, to the parent company and converted to U.S. dollars. There are significant risks inherent in these rather simple operations. In the table below, correctly identify whether each type of risk being described is an exchange-rate risk or a political risk.

	Exchange-Rate Risk	Political Risk
The risk that action by the host country will reduce the value of the investment
The risk of expropriation (seizure) of a foreign subsidiarys assets by the host country or restrictions on cash flows to the parent company
The risk that expected future exchange rates will differ from the actual future exchange rates when the foreign cash flows are converted into U.S. dollars

Johnson Industries has considerable operations in Indonesia, producing component electronic parts. Johnsons Indonesian operation has been very successful, but the firm is now concerned about the effect of the decline in the value of the Indonesian rupiah on the firms profits.

Which type of multinational capital budgeting risk is being illustrated by Johnsons situation?

Political risk

Stand-alone risk

Market risk

Exchange-rate risk

Corporate risk

Firms may take steps to reduce the risk of investing in foreign countries.

Identify whether each of the following statements are true or false.

Statements	True	False
Generally, the political risk related to foreign investment is not added to the required rate of return.
A technique to lower the risk of multinational capital budgeting is to finance the foreign subsidiary with capital raised in a country in which the asset is not located.
A technique to lower the risk of multinational capital budgeting is to finance the foreign subsidiary with capital raised in the host country.
A tool to lower the risk of multinational capital budgeting is to purchase insurance against the loss from expropriation of funds.