Net present value of the potential U.S. investment from a project perspective.

Sample Solution

     

To determine the expected NPV of a potential U.S. investment, we need to consider two perspectives:

1. Project Perspective:

This analysis focuses on the cash flows specific to the project itself, regardless of its ownership. Here's what we need:

• Project Cash Flows: Estimate all future cash inflows (revenue) and outflows (expenses) associated with the project over its lifetime. Include initial investment costs, operating expenses, and potential salvage value at the end.
• Discount Rate: Choose a discount rate that reflects the risk associated with the project. This rate represents the minimum acceptable return on investment for undertaking the project.

Full Answer Section

     

2. Parent Company Perspective:

This analysis considers the impact of the investment on the overall value of the U.S. parent company. Here's what's needed:

• Project Cash Flows: Same as project perspective, but consider the portion of cash flows that will flow back to the U.S. parent company after accounting for taxes, local reinvestments, and any repatriation restrictions in the host country.
• Cost of Capital: Use the U.S. parent company's cost of capital, which reflects the risk associated with the company's overall portfolio of investments. This rate may be different from the project's discount rate.
• Currency Considerations: If the investment involves a foreign country, consider currency exchange rates and potential fluctuations. You might need to convert foreign cash flows to U.S. dollars using appropriate exchange rates.

NPV Calculation (Parent Company Perspective): NPV (Parent) = Σ ( Discounted Cash Flow to Parent at Year t / (1 + Cost of Capital)^t ) - Initial Investment Key Differences:

• Cash Flows: Project perspective uses all project cash flows, while the parent company perspective considers only the portion flowing back to the U.S. parent.
• Discount Rate: Project perspective uses a project-specific discount rate, while the parent company perspective uses its overall cost of capital.
• Currency: The parent company perspective might require currency conversions for foreign investments.

Conclusion: By calculating the NPV from both perspectives, you can assess the project's attractiveness from both a standalone project viewpoint and its impact on the U.S. parent company's value. A positive NPV in both perspectives suggests a potentially worthwhile investment.