Capital Expenditure and Net Present Value Essay

Exclusively available on Available only on IvyPanda® Made by Human No AI

Conditions under which the capital expenditure of a foreign subsidiary might have a positive NPV in total currency terms but be unprofitable from the parent firms perspective

The Net Present Value (NPV) of a capital project is the current value of all cash inflows together with those at the termination of the project less the current value of all cash outflows (Ross et al., 2008). There are other methods of evaluating the capital expenditures including the IRR and the payback method, however, NPV takes into consideration the discounting factors and compensates conflicts that may accrue from the other methods (Ross et al., 2008). The rule of NPV is to accept a project if the NPV ≥ 0 and to reject the project if NPV < 0. This NPV decision rule is considered to be the superior framework for evaluating capital budgeting expenditure (Eun & Resnick, 2007).

Main body

The goal of any investment is to maximize the returns. Maximizing on returns translates into the optimization of the shareholder’s wealth. In essence, big firms normally open their subsidiaries in foreign countries in order to maximize the wealth of the shareholders. These subsidiaries make capital investments that are expected to benefit the parent firm. However, this would not be the case depending on many factors including the inflation rates of the host country, differences in tax regimes, remittance restriction, and the exchange rate (Ross et al., 2008). Therefore, financial managers of parent firms have the obligation of optimizing the shareholder’s wealth.

The valuation method for these capital investments should provide a clear indication that the parent firm would benefit from such investments (Ross et al., 2008). As indicated, NPV and APV are the most commonly used valuation methods. During the analysis of the capital investments, a condition may exist in which a subsidiary of a parent firm may have a positive NPV or APV from its perspective yet have a negative NPV or APV from the perspective of the parent firm. This scenario occurs if certain cash flows cannot be sent back to the parent firm majorly due to the transmittal limitations of the host nation (Emery et al., 2007).

Moreover, this condition occurs when the home currency is expected to increase in value considerably over the life of the project resulting in unappealing cash flows when changed into the home currency of the parent company (Eun & Resnick, 2007). Finally, the perspectives may differ under the circumstances that the tax rate of the home country is higher making the capital project be loss-making from the viewpoint of the parent firm. The impact of the conditions is that the capital project becomes unbeneficial and unappealing to the parent firm and its stakeholders (Emery et al., 2007).

Conclusion

In conclusion, a capital investment might have a positive net present value (NPV) from the foreign subsidiary perspective but a negative NPV from the parent firm’s perspective under two conditions. First, if all the host countries’ cash flows are illegal to be sent back to the parent firm (Emery et al., 2007). Secondly, when the assumptions of purchasing power parity (PPP) do not hold. In the condition that purchasing power parity does not hold, the real exchange rate value will decrease in terms of the host country currency resulting in after-tax cash-flows yielding a reduced amount of units of the home currency (Eun & Resnick, 2007). This would be unexpected from the perspective of the parent firm. Further, this would yield a negative NPV.

References

Emery, D., Finnerty, J. & Stowe, J. (2007). Corporate financial management. New Jersey, NJ: Pearson-Prentice Hall.

Eun, C., & Resnick, B. (2007). International financial management. New York, NY: McGraw-Hill.

Ross, S., Westerfield, R. & Jaffe, J. (2008). Corporate finance. New York, NY: McGraw-Hill/Irwin.

More related papers Related Essay Examples
Cite This paper
You're welcome to use this sample in your assignment. Be sure to cite it correctly

Reference

IvyPanda. (2021, May 17). Capital Expenditure and Net Present Value. https://ivypanda.com/essays/capital-expenditure-and-net-present-value/

Work Cited

"Capital Expenditure and Net Present Value." IvyPanda, 17 May 2021, ivypanda.com/essays/capital-expenditure-and-net-present-value/.

References

IvyPanda. (2021) 'Capital Expenditure and Net Present Value'. 17 May.

References

IvyPanda. 2021. "Capital Expenditure and Net Present Value." May 17, 2021. https://ivypanda.com/essays/capital-expenditure-and-net-present-value/.

1. IvyPanda. "Capital Expenditure and Net Present Value." May 17, 2021. https://ivypanda.com/essays/capital-expenditure-and-net-present-value/.


Bibliography


IvyPanda. "Capital Expenditure and Net Present Value." May 17, 2021. https://ivypanda.com/essays/capital-expenditure-and-net-present-value/.

If, for any reason, you believe that this content should not be published on our website, please request its removal.
Updated:
This academic paper example has been carefully picked, checked and refined by our editorial team.
No AI was involved: only quilified experts contributed.
You are free to use it for the following purposes:
  • To find inspiration for your paper and overcome writer’s block
  • As a source of information (ensure proper referencing)
  • As a template for you assignment
Privacy Settings

IvyPanda uses cookies and similar technologies to enhance your experience, enabling functionalities such as:

  • Basic site functions
  • Ensuring secure, safe transactions
  • Secure account login
  • Remembering account, browser, and regional preferences
  • Remembering privacy and security settings
  • Analyzing site traffic and usage
  • Personalized search, content, and recommendations
  • Displaying relevant, targeted ads on and off IvyPanda

Please refer to IvyPanda's Cookies Policy and Privacy Policy for detailed information.

Required Cookies & Technologies
Always active

Certain technologies we use are essential for critical functions such as security and site integrity, account authentication, security and privacy preferences, internal site usage and maintenance data, and ensuring the site operates correctly for browsing and transactions.

Site Customization

Cookies and similar technologies are used to enhance your experience by:

  • Remembering general and regional preferences
  • Personalizing content, search, recommendations, and offers

Some functions, such as personalized recommendations, account preferences, or localization, may not work correctly without these technologies. For more details, please refer to IvyPanda's Cookies Policy.

Personalized Advertising

To enable personalized advertising (such as interest-based ads), we may share your data with our marketing and advertising partners using cookies and other technologies. These partners may have their own information collected about you. Turning off the personalized advertising setting won't stop you from seeing IvyPanda ads, but it may make the ads you see less relevant or more repetitive.

Personalized advertising may be considered a "sale" or "sharing" of the information under California and other state privacy laws, and you may have the right to opt out. Turning off personalized advertising allows you to exercise your right to opt out. Learn more in IvyPanda's Cookies Policy and Privacy Policy.

1 / 1