CORPORATE FINANCE VIII ESCP-EAP - European Executive MBA 25&26 January 2006, Berlin I International...
Transcript of CORPORATE FINANCE VIII ESCP-EAP - European Executive MBA 25&26 January 2006, Berlin I International...
CORPORATE FINANCEVIII
CORPORATE FINANCEVIII
ESCP-EAP - European Executive MBA25&26 January 2006, Berlin
IInternational Finance and
Investment Decisions
I. ErtürkSenior Fellow in Banking
INTERNATIONAL INVESTMENT DECISIONS
INTERNATIONAL INVESTMENT DECISIONS
METHOD 1 METHOD 2STEP 1 ESTIMATE FUTURE ESTIMATE FUTURE
CASH FLOW IN FC CASH FLOW IN FC
STEP 2 CONVERT TO HC CALCULATE PV AT FORECASTED USING FC
EXCHANGE RATES DISCOUNT RATE
...STEP 3 CALCULATE PV CONVERT TO HC USING HC USING SPOT RATE
DISCOUNT RATE HC: HOME CURRENCY
FC: FOREIGN CURRENCY
EXAMPLEEXAMPLE
US STEEL’S EXPECTED NET CASH FLOWS IN THOUSANDS OF EUROS
YEAR 0 1 2 3 4 5
CASH FLOW-1,000 400 450 510 575650
HOW MUCH ARE THESE CASH FLOWS WORTH TODAY IF OUTLAND WANTS 16% DOLLAR RETURN FROM ITS DUTCH INVESTMENT?
METHOD 2METHOD 2
NEED TO CALCULATE DUTCH RISK-ADJUSTED DISCOUNT RATE
US risk free rate= 8% Euro risk free rate=9%(1 +U.S. RISK-ADJUSTED DISCOUNT RATE)
= ( 1 + U.S. NOMINAL RISK-FREE INTEREST RATE) x (1 + RISK-PREMIUM)
1.16 = 1.08 x (1 + RISK-PREMIUM)
(1 + RISK PREMIUM) = 1.074(1 + DUTCH RISK-ADJUSTED DISCOUNT RATE)
..= ( 1 +DUTCH NOMINAL RISK-FREE INTEREST RATE) x (1 + RISK-PREMIUM)
= 1.09 x 1.074 = 1.171 OR 17.1%
METHOD 2METHOD 2
DISCOUNT EURO CASH FLOW AT EURO OPPORTUNITY COST OF CAPITAL– OBTAIN EURO PV OF CASH FLOWS– CONVERT TO DOLLARS AT SPOT RATE
YEAR 0 1 2 3 4 5
CASH FLOW-1,000 400 450 510 575650
NPV @ 17.1% = €588
CONVERT TO US$ @ €1=$1.10 $647
METHOD 1METHOD 1
-FORECAST EXCHANGE RATE
-CONVERT FC CASHFLOW TO HC CASHFLOW
-DISCOUNT AT HC COST OF CAPITAL TO FIND
HC NPV
YEAR 0 1 2 3 4 5
€CASH FLOW -1,000 400 450 510575 650
FX RATE 1.10 0.90 0.85 0.90 0.92 0.94
$CASH FLOW -1,100 360 383 459 529611
NPV @ 16% $372
FORECASTING FX RATES & THREE PARITIES
FORECASTING FX RATES & THREE PARITIES
INTEREST RATE PARITY– relates today’s spot exchange rate to today’s
forward exchange rate– foreign exchange markets and money markets
INTERNATIONAL FISHER EFFECT– estimating future spot exchange rate from
interest rate differentials in capital markets– foreign exchange markets and capital markets
PURCHASING POWER PARITY– estimating future spot exchange rate from
inflation differentials– foreign exchange markets and goods markets
INTEREST RATES AND EXCHANGE RATES
INTEREST RATES AND EXCHANGE RATES
€1MM TO BORROW FOR 1YEARCHOICE BETWEEN
– EURO LOAN AT 7 5/8 %– SWISS FRANC LOAN AT 4 9/16 %
EURO LOAN– AT END OF YEAR 1,000,000 x 1,07625 =
€1,076,250SWISS FRANC LOAN
– SPOT RATE SFr1.3125/€– BORROW 1,000,000 x 1.3125 = SFr1,312,500– AFTER 1 YEAR, PAY– 1,312,500 x 1.045625 = SFr1,372,383
COVERED INTEREST RATE ARBITRAGECOVERED INTEREST RATE ARBITRAGE
YOU WANT TO BE SURE OF THE EXCHANGE RATE YOU RECEIVE IN A YEAR’S TIME– YOU FIX TODAY THE PRICE AT WHICH YOU
WILL BUY YOUR FRANCS AT END OF YEAR BY BUYING THEM FORWARD
– 1-YEAR FORWARD RATE IS SFr1.275/€– AFTER 1 YEAR, PAY 1,372,383/1.275 =
€1,076,379TWO INVESTMENTS OFFER (ALMOST) SAME
RETURNIF DOMESTIC INTEREST RATE DIFFERENT FROM
COVERED FOREIGN INTEREST RATE– OPPORTUNITY FOR RISKLESS ARBITRAGE
INTEREST RATE PARITYINTEREST RATE PARITY
THE SWISS FRANC BORROWING GIVES YOU LOWER INTEREST RATE– BUT YOU LOSE BY BUYING FRANCS FORWARD – IN A YEAR’S TIME MORE EUROS NEEDED THAN
TODAY
fSFr/€ = sSFr/€ * (1 + rSFr ) / (1 + r€) = SFr1,275/€
INTEREST RATE PARITY THEOREM– INTEREST RATE DIFFERENTIAL = DIFFERENTIAL BETWEEN FORWARD AND SPOT RATES
INTERNATIONAL FISHER EFFECTINTERNATIONAL FISHER EFFECT
CAPITAL FLOWS WHERE REAL RETURNS ARE GREATEST
IN EQUILIBRIUM– EXPECTED REAL RETURN ON CAPITAL SAME
IN ALL COUNTRIESFISHER EQUATION
st+1 = st * (1 + rforeign ) / (1 + rhome)
REAL INTEREST RATES AND CAPITAL MARKET EQUILIBRIUMREAL INTEREST RATES AND
CAPITAL MARKET EQUILIBRIUMIN SHORT RUN
– GOVERNMENTS HAVE CONTROL OVER INTEREST RATES
– CAN ACHIEVE REAL INTEREST RATES BELOW OTHER COUNTRIES
BUT CANNOT MAINTAIN POSITION INDEFINITELY– INVESTORS WILL TRANSFER CASH TO HIGH
REAL INTEREST COUNTRIESCOUNTRIES WITH HIGHEST INFLATION HAD
HIGHEST INTEREST RATES MUCH SMALLER DIFFERENCES BETWEEN REAL
INTEREST RATES THAN BETWEEN NOMINAL RATES
GOODS MARKET AND FX MARKETGOODS MARKET AND FX MARKET
SAME FORCES THAT TEND TO MAKE PRICE LEVELS ROUGHLY SAME ACROSS SUPERMARKETS OFFERING SIMILAR SERVICES
CALLED – LAW OF ONE PRICE (TALKING ABOUT SINGLE
GOOD)– PURCHASING POWER PARITY(TALKING
ABOUT LEVEL OF PRICES IN GENERAL)PPP IMPLIES THAT
– ANY DIFFERENCES IN INFLATION BETWEEN THE TWO COUNTRIES
– OFFSET BY CHANGE IN EXCHANGE RATE
PURCHASING POWER PARITYPURCHASING POWER PARITY
IF INFLATION 4% IN EU , 1% IN SWITZERLAND– TO EQUALIZE EURO PRICES OF GOODS IN EU
AND SWITZERLAND– NUMBER OF SWISS FRANCS YOU CAN BUY
FOR A EURO MUST FALL BY (1.01/1.04) - 1 OR ABOUT 3%
st+1 = st * (1 + iforeign ) / (1 + ihome)
EXCHANGE RATES AND INFLATIONEXCHANGE RATES AND INFLATION
PLAZA ACCORD AND US DOLLAR DEVALUATION IN 1986
ERM CRISIS AND STERLING DEVALUATION IN 1992
MEXICAN PESO CRISIS IN 1994
FINANCIAL CRISIS IN THE FAR EAST IN 1997
ARGENTINA IN 2002
PPP WORKS IN THE LONGER TERM AS A TREND RATHER THAN ACCURATE POINT ESTIMATE
TRADEABLE GOODS INDEX VS. CPI
INTERNATIONAL FINANCIAL MANAGEMENT
INTERNATIONAL FINANCIAL MANAGEMENT
MANY COMPANIES DO BUSINESS OVERSEASSAME OBJECTIVES AS DOMESTIC FINANCE
– BUT ADDITIONAL PROBLEMSMULTIPLE CURRENCIES
– HOW CAN FIRM PROTECT ITSELF AGAINST EXCHANGE RISKS?
DIFFERING INTEREST RATES ACROSS COUNTRIES
INTERNATIONAL FINANCIAL MANAGEMENTINTERNATIONAL FINANCIAL MANAGEMENT
SHOULD PARENT – PROVIDE FINANCING?– TRY TO FINANCE LOCALLY?– BORROW WHERE INTEREST RATES LOWEST?
HOW SHOULD INTERNATIONAL COMPANIES MAKE CAPITAL BUDGETING DECISIONS?– WHAT DISCOUNT RATE?– HOW DOES FINANCING METHOD AFFECT
CHOICE OF PROJECT?
COST OF CAPITAL FOR FOREIGN INVESTMENT
COST OF CAPITAL FOR FOREIGN INVESTMENT
THINK MORE CAREFULLY ABOUT RISK OF OVERSEAS PROJECT– WHAT RETURN DO INVESTORS REQUIRE FPR
TAKING THIS RISK?ANSWER DEPENDS ON OTHER SECURITIES
INVESTOR HOLDS IN HER PORTFOLIOCASE 1
– SINGLE WORLD CAPITAL MARKET INVESTORS FROM EACH COUNTRY HOLD WELL-DIVERSIFIED INTERNATIONAL PORTFOLIOS
– RISK OF FOREIGN PROJECT IS PROJECT’S BETA RELATIVE TO WORLD MARKET PORTFOLIO
– SAME BETA AS LOCAL COMPANY
COST OF CAPITAL FOR FOREIGN INVESTMENT
COST OF CAPITAL FOR FOREIGN INVESTMENT
CASE 2OTHER EXTREMECAPITAL MARKETS COMPLETELY SEGMENTEDLOCAL INVESTORS HOLD ONLY LOCAL STOCKS
– FOREIGN INVESTORS HOLD ONLY FOREIGN STOCKS
FOREIGN PROJECT AND A LOCAL COMPANY DO NOT FACE SAME RISK– LOCAL PLC’S RISK IS MEASURED BY ITS BETA
RELATIVE TO LOCAL MARKET– MAY BE LOW RISK IF FOREIGN MARKET
NOT CLOSELY CORRELATED WITH LOCAL MARKET
– FOREIGN PLC MEASURES ITS RISK RELATIVE TO FOREIGN MARKET
COST OF CAPITAL FOR FOREIGN INVESTMENT
COST OF CAPITAL FOR FOREIGN INVESTMENT
SINGLE WORLD COMPLETELY SEGMENTED CAPITAL MARKET CAPITAL MARKETS
INTERNATIONAL DOMESTIC DIVERSIFICATION
DIVERSIFICATION
RISK MEASURED RELATIVE RISK MEASURED RELATIVETO WORLD MARKET INDEX TO DOMESTIC INDEX
NO FURTHER GAINS FROM LARGE GAINS FROM INTERNATIONAL INTERNATIONAL DIVERSIFICATION
DIVERSIFICATION
LOCAL FIRM HAS SAME LOCAL FIRM HAS DIFFERENT
COST OF CAPITAL AS COST OF CAPITAL THAN FOREIGN FIRM FOREIGN FIRM
COST OF CAPITAL FOR FOREIGN INVESTMENT
COST OF CAPITAL FOR FOREIGN INVESTMENT
MARKETS PARTIALLY SEGMENTEDLOCAL INVESTORS FREE TO HOLD FOREIGN
SHARES– BUT ONLY SMALL PART OF PORTFOLIO IN
FOREIGN STOCKS– PERHAPS BECAUSE OF COSTS OF GETTING
INFORMATIONWORLD IS CHANGINGLARGE INSTITUTIONAL INVESTORS INCREASING
OVERSEAS INVESTMENTSMUTUAL FUNDS INVESTING IN FOREIGN
STOCKS FOR INDIVIDUAL INVESTORS– EVEN IN SMALLER STOCK MARKETS– INDIA– THAILAND– CHILE
FUDGE FACTORSFUDGE FACTORS
MANAGERS OFTEN MARK UP DOMESTIC COST OF CAPITAL BY A FUDGE FACTOR– WHEN CONSIDERING FOREIGN INVESTMENTS– PERHAPS TO COVER RISK OF EXPROPRIATION– FOREIGN EXCHANGE RESTRICTIONS
BETTER LEAVE DISCOUNT RATE ALONE– LIKELY TO BE UNSYSTEMATIC RISKS
REDUCE EXPECTED CASH FLOWS INSTEADSUPPOSE THERE IS A 10% CHANCE OF PLANT
BEING SHUT DOWN BECAUSE OF POLITICAL UNREST– REDUCE EXPECTED CASH FLOW BY 10%
ADJUSTING CASH FLOWS BRINGS ASSUMPTIONS ABOUT POLITICAL RISK INTO THE OPEN
PROJECT CASH FLOWS FOR KIMTRON, ALL-EQUITY BASIS (in millions of won)-------------- --------- ---------- ---------- ---------- ---------- ---------- ----------Item Year 0 1 2 3 4 5-------------- --------- ---------- ---------- ---------- ---------- ---------- ----------
(1) EBIT 810 1,745 2,820 4,055 5,469(2) Less Korean taxes 243 524 846 1,216 1,641
---------- ---------- ---------- ---------- ---------- ----------(3) Net income, all equity basis (a) 567 1,222 1,974 2,838 3,828(4) Plus depreciation 750 750 750 750 750(5) Plus liquidation value 8,000(6) Net new invest in WC -1,200 -319 -365 -417 -478(7) Less cost of project -7,200
---------- ---------- ---------- ---------- ---------- ----------(8) Net cash flow -7,200 117 1,653 2,360 3,171 12,100(9) PV factor 1.000 0.820 0.672 0.551 0.451 0.370
---------- ---------- ---------- ---------- ---------- ----------(10) PV each year -7,200 96 1,111 1,299 1,431 4,477(11) Cum NPV -7,200 -7,104 -5,993 -4,694 -3,263 1,214(12) IRR = 26.78%-------------- --------- ---------- ---------- ---------- ---------- ---------- ----------
AFTER-TAX DIVIDEND RECEIVED BY FAIRTEL FROM KIMTRON-------------- --------- ---------- ---------- ---------- ---------- ---------- ----------Item Year 0 1 2 3 4 5-------------- --------- ---------- ---------- ---------- ---------- ---------- ----------IN MILLIONS OF WON
(1) Cash dividend 369 794 1,283 1,845 2,488 (2) Add back payout % of Korean income tax paid 158 340 550 791 1,066
---------- ---------- ---------- ---------- ---------- (3) Grossed-up dividend (won) 527 1,134 1,833 2,635 3,555 (4) Exchange rate (won/$) 800 824 849 874 900 927
IN THOUSANDS OF DOLLARS
(5) Grossed-up dividend 639.0 1,336.7 2,097.2 2,926.9 3,833.1 (6) U.S. taxes 217.2 454.5 713.0 995.2 1,303.3 (7) Less credit for Korean taxes 191.7 401.0 629.1 878.1 1,149.9
---------- ---------- ---------- ---------- ---------- (8) Additional US tax due 25.6 53.5 83.9 117.1 153.3 (9) Excess US tax credit 0 0 0 0 0
---------- ---------- ---------- ---------- ----------(10) Dividend rec'd by Fairtel after-tax421.7 882.2 1,384.1 1,931.8 2,529.9-------------- --------- ---------- ---------- ---------- ---------- ---------- ----------
NET PRESENT VALUE TO FAIRTEL OF CASH FLOWS FROM KIMTRON-------------- --------- ---------- ---------- ---------- ---------- ---------- ----------Item Year 0 1 2 3 4 5-------------- --------- ---------- ---------- ---------- ---------- ---------- ----------IN MILLIONS OF WON
(1) License fee 440 504 577 660 756 (2) Margin on exports to Kimtron 320 367 420 481 551
---------- ---------- ---------- ---------- ---------- ---------- (3) Total receipts 760 870 997 1,141 1,307 (4) Exchange rate (won/$) 800.00 824.00 848.72 874.18 900.41 927.42
IN THOUSANDS OF DOLLARS
(5) Pre-tax receipts: 922.3 1,025.5 1,140.2 1,267.7 1,409.5 (6) Less U.S. taxes: 313.6 348.7 387.7 431.0 479.2
---------- ---------- ---------- ---------- ---------- ---------- (7) Fees & export profits after-tax 608.7 676.8 752.5 836.7 930.3 (8) After-tax dividend 421.7 882.2 1,384.1 1,931.8 2,529.9 (9) Project cost (9,000.0)(10) Liquidation value 8,626.1
---------- ---------- ---------- ---------- ---------- ----------(11) Net cash flow (9,000.0) 1,030.4 1,559.0 2,136.7 2,768.5 12,086.2(12) PV factor 1.000 0.820 0.672 0.551 0.451 0.370
---------- ---------- ---------- ---------- ---------- ----------(13) PV each year (9,000.0) 844.6 1,047.5 1,176.7 1,249.7 4,471.9(14) Cum NPV (8,155.4) (7,107.9) (5,931.2) (4,681.6) (209.7)(15) IRR= 21.26%============== ========= ========== ========== ========== ========== ========== ==========
PAGINAS AMERALASPAGINAS AMERALAS
Yellow pages Segmented CAPM ApproachYear 2000
Argentina Brazil Chile
US Risk-Free Rate 7.00% 7.00% 7.00% RfPolitical Risk Premium (bonds) 4.00% 5.00% 0.75% Rf
US Unlevered Beta 0.78 0.78 0.78US Levered Beta 0.91Country Beta 1.96 2.42 0.65Correction for Correlation 0.6 0.6 0.6Country risk adjusted Beta 1.07 BetaUS Equity Market Risk Premium 5.50% 5.50% 5.50% Risk premiumUS$ Cost of Equity for Local Bus. 16.89% Re
Debt/Equity Ratio 25.00%Local Tax Rate 35.00% 35.00% 15.00%
Local US$ Cost of Debt 9.80% 12.40% 7.90%After-tax Cost of Debt 6.37% Rd
Weight of Debt 20.00% 20.00% 20.00% D/VWeight of Equity 80.00% 80.00% 80.00% E/V
WACC 14.79% 0.00% 0.00% WACC