Capital Budgeting, Research Paper Example

Capital budgeting is probably the most crucial financial decision of a firm. In its extensive study of both public and private organizations’ capital budgeting practices, the Government Accountability Office (GAO) identified elements of capital budgeting that either contribute to or jeopardize success (cited in Jones, & McCaffery, 2008, p. 613). The elements found in successful organization can be ranked on a continuum of critical-to-helpful attributes. Similarly, the elements in an unsuccessful company range from harmful-to-critical attributes (p. 613). The successful organization is able to minimize the impact on its service-delivery system when operating conditions change its environment. In describing the elements, GAO stated that “a successful company is the one that can, even under bad circumstances, acquire and/or maintain physical capital without jeopardizing its mission or its customers” (p. 613). By bad circumstances, GAO meant“declining resources, political instability, or severe conditions among interest groups” (p. 613).

Although the basic principles of capital budgeting analysis are the same for both domestic and foreign operations, Grigg (2010, p. 183) stressed that someelements need to be mentioned.  First, cash flow estimations generally are much more complex for overseas investments. Most multinational firms set up a separate subsidiary in each international country in which they work, and their relevant cash flows for these subsidiaries are the earnings and dividends that can be returned to the parent company. Second, these cash flows much be converted into the currency of the parent company, and thus are subject to future exchange rate changes. Third, earnings and dividends normally are taxed by both international and national governments. Fourth, a foreign government might restrict the amount of cash that can be returned to the parent company, perhaps to force multinational firms to reinvest earnings in the host company or to prevent large currency outflows that might affect the exchange rate.

Whatever the host country’s motivation, the result is that the parent corporation cannot use cash flows blocked in the foreign country to pay current dividends to its shareholders, nor does it have the flexibility to reinvest cash flows elsewhere in the world. Therefore, the cash flows relevant to the analysis of an international investment are the cash flows that the subsidiary legally can send back to the parent.

References

Grigg, Neil S. (2010). Economic and Finance for Engineers and Planners: Managing Infrastructure and Natural Resources. ASCE Publications.

Jones, L. R., & McCaffery, Jerry. (2008). Budgeting, Financial Management, and Acquisition Reform in the U.S. Department of Defense. IAP.