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 0 The risk of expropriation (seizure) of a foreign subsidiary's assets by the host country or restrictions on cash flows to the parent company The uncertainty associated with the value of cash flows generated in one currency and then converted to another Johnson Industries has considerable operations in Indonesia, producing component electronic parts. Johnson's Indonesian operation has been very successful, but the firm is now concerned about its host country preventing Johnson from repatriating a majority of the profits. Which type of multinational capital budgeting risk is being illustrated by Johnson's situation? Political risk O Stand-alone risk O Exchange-rate risk Corporate risk O Market 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. 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 0 The risk of expropriation (seizure) of a foreign subsidiary's assets by the host country or restrictions on cash flows to the parent company The uncertainty associated with the value of cash flows generated in one currency and then converted to another Johnson Industries has considerable operations in Indonesia, producing component electronic parts. Johnson's Indonesian operation has been very successful, but the firm is now concerned about its host country preventing Johnson from repatriating a majority of the profits. Which type of multinational capital budgeting risk is being illustrated by Johnson's situation? Political risk O Stand-alone risk O Exchange-rate risk Corporate risk O Market 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