A simple rule for multinational capital budgeting

Abstract

Multinational capital budgeting has been a topic mired in considerable complexities. Even in its most basic problem where the only source of uncertainty is the possibility of currency fluctuations in alI future periods, the solutions are still far from simple. In the ‘theoretically’ correct approach, an international capital asset pricing has to be derived such that an appropriate discount rate could be calculated (see for example [2]). The model involves the specification of the stochastic processes governing the project cash flows, the exchange rates, and the covariances between the project and the exchange rates, among the exchange rates, and among ail assets. Empirically, estimation of the discount rate requires the world market (or consumption) portfolio, risk aversion parameter, and risk free interest rates in different countries. The approaches in the textbooks, e.g., [1, 4, 6, 8,9], although simpler, still require a substantial amount of forecasted variables. In particular, the approach in which local cash flows are translated into home currency and discounted at the home discount rate requires the manager to forecast the expected spot exchange rates, or their equivalent, the expected inflation rates in both countries e.g., [6], for all time periods during the life of the project t = 1,2,. . . ,T. The purpose of this note is to propose that under certain conditions, there is a much simpler rule for evaluating multinational capital budgeting problem.