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Lecture Global financial management - Topic 7: Global valuation and capital budgeting

Topic 7 - Global valuation and capital budgeting. In this chapter, students will be able to understand value foreign investments using sovereign risk premiums, foreign proxies, cashflow adjustments and exchange rate forecasts. | Topic #7: Global Valuation and Capital Budgeting L. Gattis The Pennsylvania State University 0 Global Finance Learning Objectives 1 Value foreign investments using sovereign risk premiums, foreign proxies, cashflow adjustments and exchange rate forecasts Review Problem: Domestic NPV 2 Caterpillar, Inc. is investing $100M to build a plant in Indiana and expects three years of annual EBIT of $25M, depreciation of $15M, CAPEX of $10M, and additions to working capital $5M. CAT’s tax rate is 40% and beta is 1.7. The risk free rate is 2% and the market risk premium is 5%. CAT’s credit spread on its debt is 4% and D/E ratio is 0.6. CAT estimates that the investment is worth 5 times FCF in year 4. What is the NPV of the investment? (Hint: Compute NPV for initial investment + the present value of 3 FCFs + the present value of the exit multiple valuation) Hints:CF(0)=-$100, CF(1)=25*(1-.4)+15-10-5=$15, D/(D+E)=.6/1.6 How would you value if the investment is in India and cashlows are in rupee? Review: Capital Budgeting Formulas 3 FCFF = EBIT*(1-Tc) + Deprec&Amort – CAPEX - ∆NWC NPV, WACC, and Risk 4 Same Business Risk Same Leverage Compute WACC using current values of the Firm’s E, D, Kd, and Ke Different Capital Structure (Leverage) Steps: (1) Re-lever Firm’s beta (2) compute new debt spread (3) Compute new E, D, Kd, Ke, and WACC Different Business Risk (Incl. Country Risk) Methods Proxy Beta and Debt Spread Sov. Risk Prem. FCF adjustments Country Risk (a.k.a. Political Risk) 5 Country Risk is a term for the risk of operating in a foreign country. These risks include, but are not limited to: Currency crisis Expropriation Legal risk Trade Barriers (Tariffs, Quotas) Changes in regulation Changes in taxation (home or host) Inflation and Exchange rate risk Economic crisis Terrorism, Violence, Crime Infrastructure failures (power, transportation, communication, etc.) 6 Country Risk and Sovereign Risk Sovereign Debt Risk Country Risk Doing Business Sovereign Risk Premiums are . | Topic #7: Global Valuation and Capital Budgeting L. Gattis The Pennsylvania State University 0 Global Finance Learning Objectives 1 Value foreign investments using sovereign risk premiums, foreign proxies, cashflow adjustments and exchange rate forecasts Review Problem: Domestic NPV 2 Caterpillar, Inc. is investing $100M to build a plant in Indiana and expects three years of annual EBIT of $25M, depreciation of $15M, CAPEX of $10M, and additions to working capital $5M. CAT’s tax rate is 40% and beta is 1.7. The risk free rate is 2% and the market risk premium is 5%. CAT’s credit spread on its debt is 4% and D/E ratio is 0.6. CAT estimates that the investment is worth 5 times FCF in year 4. What is the NPV of the investment? (Hint: Compute NPV for initial investment + the present value of 3 FCFs + the present value of the exit multiple valuation) Hints:CF(0)=-$100, CF(1)=25*(1-.4)+15-10-5=$15, D/(D+E)=.6/1.6 How would you value if the investment is in India and cashlows are in rupee? .