Capital Budgeting of Globalco Case Solution

The change in the initial investment is $10 million, which is less in the dollar amount due to the changing value from one currency over another. Therefore,in order to achieve the desired level of cash flows for the US, the hedging tool should be applied to recover all the potential losses occurred through the depreciated value of the currency.

Conclusion

The overall results under the budgeting show that currency value is the key driver for generating the desire level of earnings because every economy has the uncertainty to maintain its efficiency. In the case of US, the currency value is 10 times lower than Euro and therefore reflects the high cost of investment in Europe. According to the expected results, they indicate that the operations in Europe would generate high cash flows due to low tax rates and inflation, but if change the earnings from Euro to US than the parent company would suffer a loss because of proposed withholding tax of the remitted funds as well as less currency value.Therefore,in order to control the potential losses in the future, Globalco should enter into the hedge agreement and fix the level of currency rate throughout the selected years. This will help to manage all the obstacles that could reduce the earnings ratio and therefore increase the foreign direct investment activity within a country. The other advantage would be to reduce the economic fluctuations through fixed hedging agreement.It is concluded that whether the investment will occur in Europe or US, the currency will be sensitive against the future benefits or losses. Therefore if the currency fluctuation will be high in Europe than the dollar should be fixed against the return to be transferred into the actual currency.The main reason to determine the capital budgeting process will be to analyse the potential advantages as well disadvantages of the setup in offshore and to see the response of the existing shareholders regarding the benefits of future returns or a potential loss due to poor economic condition in a country where the operation will take place. Therefore, the economic conditions are the main sources to identify the potential success of every foreign investment businesses.

  Exhibit 1

US Dollars      
Years Cash Flows PV @ 20% NPV
1               21,859 0.8333     18,216
2               25,571 0.6944     17,757
3               27,780 0.5787     16,076
4               30,149 0.4823     14,540
5               32,686 0.4019     13,136
6               35,416 0.3349     11,861
7               38,346 0.2791     10,702
8               41,487 0.2326      9,648
9               44,865 0.1938      8,695
10               48,491 0.1615      7,832
  NET NPV   128,463

 Exhibit 2

Euro      
Years Cash Flows PV @ 20% NPV
1               24,288 0.8333     20,240
2               28,412 0.6944     19,730
3               30,866 0.5787     17,863
4               33,499 0.4823     16,155
5               36,318 0.4019     14,596
6               39,351 0.3349     13,179
7               42,607 0.2791     11,891
8               46,096 0.2326     10,721
9               49,850 0.1938      9,661
10               53,879 0.1615      8,702
  NET NPV   142,737

 Exhibit 3

NPV in Euro and Dollar
Present Value in Dollars             128,463
Present Value in Euro             142,737
Differences in Salvage Values
Discounted Salvage Value in US                 1,454
Discounted Salvage Value in Euro                 1,615
Initial Investment in Dollars               90,000
Initial Investment in Euro             100,000
Total Net Present Value in Dollars               39,916
Total Net Present Value in Euro               44,352
Net Difference                 4,435

Exhibit 4

Payback (US Dollars)      
Years Cash out Flows Cash inflows Payback
1  $        (90,000)         21,859  $(68,141)
2  $        (68,141)         25,571  $(42,570)
3  $        (42,570)         27,780  $(14,790)
4  $        (14,790)         30,149  $ 15,359

 Exhibit 5

Payback(Euro)      
Years Cash out Flows Cash inflows Payback
1          (100,000)         24,288       (75,712)
2            (75,712)         28,412       (47,300)
3            (47,300)         30,866       (16,434)
4            (16,434)         33,499        17,066

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