Question

In what way multinational capital budgeting is different from the domestic capital budgeting? Explain the differences.

Answer 1

We know capital budgeting is a process to select project which is more profitable to firm and maximise  the wealth of investors. Capital budgeting involves capital expenditure on mutually exclusive and independent projects.Following are some points of difference between multinational and domestic capital budgeting

1.Exchange rate difference:

Foreign currency risk is one of the risk which is taken into consideration by MNC capital budgeting as they have to hedge cash flows in short or long term which arises due to change in exchange rates. So while evaluating projects foreign exchange difference is an important factor, it involves extra calculation to mitigate the risk. While in domestic capital budgeting this is not considered.

2. Tax laws:

Due to difference in Tax laws and other regulatory environment in host county, there is change in cash flow from parent to host country which impacts capital budgeting decisions.This type of situation does not arise in case of domestic capital budgeting.

3.Estimation of Inflation rates:

Inflation rates are also taken into consideration while capital budgeting decision. As in Multinational budgeting cash flows are in different currencies, so while evaluating project again exchange rates are taken into consideration for proper forecasting of inflation rates which is not required in domestic capital budgeting as deals in local currency.

4. Evaluating capital sources:

If capital is raised through capital market, then in cross boarder cost of financing is also expensive.So these factor is also considered in Multinational capital budgeting as to carefully examine financing aspects according to host country regulatory requirement.In domestic capital budgeting these factor are important but involves less regulation as compare to MN budgeting.

5.Transfer pricing:

In multinational budgeting transfer pricing is also an important factor from parent to subsidery.because of transfer prices the value of cash flow and project got decreased.So various adjustment are done reduce the effect of transfer prices on capital budgeting decisions,which is not required in domestic budgeting.