Executive Summary
The study includes New Zealand Aluminum Smelters an aluminum manufacturing company that is willing to construct a new aluminum smelting & manufacturing plant in Vietnam. In this study, the company has been advised with methods of going international and makes choices of raising capital. It has been found that, methods of going international include importing & exporting, licensing, franchising, joint venture & strategic partnerships and FDI or Foreign Direct Investment. It has been recommended to the firm to opt for FDI as a method of going international. In addition, it is also recommended to the firm to opt for loans from the financial institutions and commercial banks.
Table of Contents
Introduction 2
Discussion & Critical Analysis 2
A. International business methods 2
B. Finance options available for international business 3
C. Risks involved in international business: 4
D. Multinational capital budgeting 5
E. Issues for non-domestic project 6
F. Technique of capital budgeting (NPV) 7
G. Components of capital budgeting 7
H. WACC / NPV of new aluminum smelting manufacturing plant in Vietnam 9
Recommendation 14
Conclusion 15
References 17
Introduction
International financial management mainly focuses upon managing finance in foreign business. Moreover, it includes trading of money with the process of exchange of foreign currencies. It is an important part of the economy as it focuses on the issues related with monetary interaction of counties. Along with this, emphasis is provided by international financial management on foreign direct investment, monetary systems and exchange rates. It acts as an essential tool for organisation in process of attaining growth. The purpose of the international financial system is to maintain peace among all the nations and enhance the efficiency of organisations operating in the global market. Hence, the current study focuses on efficient role of internal financial management in the global market that leads to enhanced performance of multinational businesses. New Zealand Aluminum Smelters an aluminum manufacturing company is willing to construct a new aluminum smelting & manufacturing plant in Vietnam. The company has been advised with methods of going international and make choices of raising capital. Thus, analysis of multinational capital budgeting, issues of non domestic projects and capital budgeting components have been assessed. Further, analysis of WACC and discounting rates has also done along with scenario analysis and sensitivity analysis.
Discussion & Critical Analysis
A. International business methods
There are several methods of going international that includes importing & exporting, licensing, franchising, joint venture & strategic partnerships and FDI or Foreign Direct Investment.
a. Importing & exporting: This method of international business includes purchasing or selling of goods from the foreign country or international markets (Kozak et al. 2017, p. 1). On one hand, importing involves purchasing of goods from the foreign country to home country. On the other hand, exporting involves selling of goods to the foreign country from home country
b. Licensing: This method of international business is an arrangement between a licensor and licensee. The licensor firm allows another party with the right of use of its intellectual property like patent, copy right, trademark and technology in exchange of loyalty.
c. Franchising: This method of international business is similar to licensing where the parent company allows other to perform business under the name of franchiser (Abraham & Schmukler, 2017, p. 2). The guidelines in case of franchising are even stricter as compared to licensing.
d. Joint venture & strategic partnerships: This method of international business is cooperation between two different firms for a specific purpose. These firms come together in order to receive mutual gain across the globe.
e. FDI or Foreign Direct Investment: This method of international business involves investment into property in a foreign country to get the benefits of tax exemptions and low labour cost. Among all the methods, the most suitable one for New Zealand Aluminum Smelters is FDI. With the help of FDI the company will be able to construct a new aluminum smelting & manufacturing plant in Vietnam.
B. Finance options available for international business
a. Commercial Banks & Financial Institutions: These financial institutions provide debts or loans to companies in foreign currency (Peymankar & Ranjbar, 2019, p. 140). For instance, Standard chartered has emerged as a key finance option in international business for Indian companies.
b. Development banks: In the recent times several development banks have come up for the purpose of international finance. These banks are approached when companies are willing to fund their international project.
c. Buyer Credits: This finance option is used by companies in financing their export over a period of time. In this case, funds are handed over directly to the importers involved in turnkey projects or capital goods.
d. Supplier credit: This finance option involves a financial institution who purchases products from the exporter or foreign buyer (Baresa, Bogdan & Ivanovic, 2016, p. 65). This finance option is suitable for transactions worth $ 100000 to $ 5000000 w3ithin the time period of 6 months to 5 years.
e. Forfeiting: This finance option involves a medium-term seller credit form provided by the trade banks. In this case, a bank purchases promissory notes for a medium term which is due from a foreign buyer to the exporter. The promissory notes are discounted at fixed rates so that cash is received by the exporter after deduction of discount.
f. Countertrade: This finance option involves an arrangement where sale to the importers is conditioned on reciprocal purchase by exporters. Therefore, instead of receiving cash the exporter gets product.
C. Risks involved in international business:
a. Credit Risk: This risk is associated with non-collection of funds in lieu of accounts receivables (Azennoud et al. 2017, p. 65). It might happen that the company provided its services but did not get any amount against the same. This results into loss of credit and is known as credit risk.
b. Intellectual Property Risk: This risk is associated with unauthorized usage of business products or properties. It might happen that the other company is misusing the right to use property in deriving own benefits.
c. Foreign Exchange Risk: This risk is associated with frequent change in the value of foreign currency. It might happen that the value of foreign currency is increasing or decreasing very often (Butler, 2016, p. 101). In this situation, New Zealand Aluminum Smelters can result into huge loss while performing international business.
d. Ethics Risks: This risk is associated with failure to meet the standard as agreed by the two parties. If the other party is involved in falsifying agreement and does not meet the requirement ethics risk takes place.
e. Shipping Risks: This risk is associated with seizure, contamination, accident, vandalism, loss, theft, and breakage during the process of shipment (Shapiro & Hanouna, 2019, p. 98). This might hamper the quality of product to be delivered to the company.
f. Country & Political Risks: This risk is associated with country differences and political instability. Any issues between Vietnam and New Zealand can affect the trade in a negative way. This includes exchange regulations, non-tariff barriers and many more.
D. Multinational capital budgeting
Based on conceptions of Shu, Zeithammer & Payne (2016, p. 240), multinational capital budgeting is similar to traditional approach of capital budgeting that generally focuses on inflow and outflow of funds associated with the project. Besides this, framework of internal capital budgeting is as similar as traditional capital budgeting approach. Further, there are five main aspects associated with international capital budgeting which are discussed as under:
• The first aspect of multinational capital budgeting focuses over traditional financial analysis approach. Moreover, the approach of traditional financial analysis mainly focuses over accounting statements and records (Borgonovo, & Plischke, 2016, p. 201). Besides this, this financial statements and records include analysis of income statement, profit and loss analysis and financial position analysis. Thus, analysis of profitability, efficiency, solvency and liquidity can be assessed by analysis of traditional financial approach.
• Another aspect of international capital budgeting is that venture has ample of project proposal having similarities in return (Benamraoui et al. 2017 p. 112). Besides this, each project provides competition to its alternative project in order to provide more return to organisation. In addition to this, comparison between profitability of each project has been made by the organisation keeping in mind the goals of venture (Leyman & Vanhoucke, 2016, p. 101). Thus, it helps the venture in earning higher revenue in the process of operating in international markets.
• Another aspect of profitable internal capital budgeting is that the NPV of the project selected by organisation must be must be higher than zero. Thus, the fulfilment of this aspect signifies viability of the project that provides more profitability to organisation. In addition to this, a situation where NPV is less than zero indicates loss of eth venture by the project and NPV is equal to zero means no profit no loss (Kaya, 2016, p. 156). Thus, it is necessary for the organisation to select project having NPV greater than zero which leads to increasing wealth of venture.
• Another essential aspect of international capital budgeting is that the chosen project of the organisation must have greatest NPV among all the projects that leads to positively affect positively over capital structure and available funds of the organisation (Creemers, 2018, p. 98).
Beside this, the international capital budgeting process is also affected by the process of domestic capital budgeting techniques that includes identification of investment appraisal. Moreover, determination of inflow and outflow of cash is essential, along with determination of initial capital requirements. Furthermore, determination of total fixed asset balance is essential along with determination of cash inflow associated with cash flows. Further, determination of NPV, IRR and present value of investment is required to assess the profitability of the project.
E. Issues for non-domestic project
Based on understandings of Kengatharan (2016, p. 56), non domestic project can be termed as foreign or international project. Moreover, the project includes issues related to costs and benefits. In addition to this, identification of different cost associated with the project such as taxation cost (Saltelli et al. 2019, p. 230), legal costs and political cost act as an issue for the organisation. Further, the presence of these costs in the cost of project does not indicate accurate figure of project within management. Thus, it becomes necessary for the manager to identify the legal, cost taxation cost and political sot of the project in order to show accurate results (Graham & Sathye (2017, p. 99). Besides this, it is necessary for the venture that parent cash flow has distinguish figure than project amount. Domestic investment has significant impact on subsidiary due to cost associated with the project (Srithongrung, Yusuf & Kriz 2019, p. 89). Lastly, the flow of cash from the investment depends over the amount of funding. Thus, these aspects act as issue in domestic investment approach.
F. Technique of capital budgeting (NPV)
As opined by Gupta (2016, p. 115) net present value approach can be used in the process of capital budgeting technique. In addition to this, NPV of a project can be identified as present value of the future cash flow of a project. Besides this, it is one of the most efficient techniques for future decision making in terms of investment. The process of NPV includes three main aspects such as NPV is greater than investment which indicates that investments must be selected (Möller & Öquist, 2019, p. 68). NPV less than investment shows it should not be selected as it leads to incurred loss for the venture. Further, NPV is equals to investment shows investment has no profit and no loss situation. Thus, in order to operate efficiently in internal market the venture must adopt project having NPV higher (Gallagher, Miao, & Ryan, 2017, p. 74). The calculation of NPV includes calculation of future value of investment. Furthermore, calculation of future value of investment includes present value of investment multiplied by discounting rate of return of alternative investments multiplied by number of time period of investment (Iooss & Saltelli, 2017, p. 215). Further, usage of NPV in capital budgeting leads toward enhancement of the profitability of the organisation
G. Components of capital budgeting
a. Cash inflow
According to Johnson & Pfeiffer (2016, p. 75), cash flow indicates the total amount of funds retained by the organisation that affects the liquidity and profitability position of venture. It is one of the important components of capital budgeting that indicates the amount of funds earned by venture (Jinadu, Soyinka & Akanfe, 2017, p. 15). In addition to this, it is necessary for the organisation to an adequate amount of cash inflow from the investment in order to operate efficiently in the international market.
b. Cash outflow
Extracted from the work of Shchurina & Prunenko (2018, p. 456), outflow of the cash indicates the amount of funds left from organisation. Thus, greater amount of outflow of funds is not desirable by the organisation as it negatively affects the liquidity position of the venture. In addition to this, presence of fewer outflows of cash indicates that the project is efficient for the performance of a company and suits the objectives of the venture (Mukhametzyanov & Pamucar, 2018, p. 56).
c. Profit
Profit indicates the amount of earnings secured within the management of organisation by the project (Srithongrung, Yusuf & Kriz, 2019, p. 256). Besides this, it is the optimum goal of an organisation to enhance its profitability in order to operate more efficiently in the international market. Hence, profitability of the venture depends over adequate capital budgeting.
d. WACC & Discount rate
As per Iachan (2020, p. 136), WACC indicates the average amount of return which the venture is required to pay to all its investors. In addition to this, it is important for the venture for enhancing its reputation in external market (Riaz, Verbič & Chapman, 2017, p. 621). Moreover, discounting rate is an essential element of investment appraisal technique which is requires determining the present value of investment.
e. Sensitivity analysis
Based on the conceptions of Graham & Sathye (2017, p. 53), sensitivity analysis indicates the uncertainty associated with output. Thus, analysis of sensitivity takes place in management by dividing the different sources of output by total output. Thus, determination of sensitivity in the project leads to enhance the occurrence of profitability by eliminating chances of loss (Liu et al. 2017, p. 567). In addition to this, its helps the business in analysing the uncertainty associated with the project.
f. Scenario analysis
Based on the conceptions of Shapiro & Hanouna (2019, p. 115), scenario analysis indicates the determination of future events that may affect the performance of venture along with its profitability. Besides this, it includes the determination of exact picture of objectives of organisation take place with the help of scenario analysis (Västi, 2016, p. 65).
g. Real option
Evaluation of real option includes allocation of adequate option from all the alternatives in order to enhance the profitability of venture by evaluating adequate option (Schneider, Michelon & Maier, 2017, p. 178). In addition to this, is an essential element of capital budgeting as it focuses on decision making process by the manager.
Cross border Acquisition analysis
Cross border Acquisition analysis mainly focuses over acquisition of ventures in domestic as well as foreign market along with acquisition of investment in order to expand business (Boolaky, Omoteso, 2016, p. 325). Besides this, it mainly includes blend of macro and micro economic factors that affect the operations of the organisation. In addition to this, it benefits the venture in terms of gaining more market share and power in industry (Crocker-Buque, T., & Mounier-Jack, S. (2016). Furthermore, it leads to provide adequate sources of finance to business along with achievement of synergy (Solovjova, Rupeika-Apoga & Romanova, 2018, p. 654). Along with this, analysis of cross border acquisition helps in retaining strategic preparatory assets to the venture along with gaining economies to scale within international market. Lastly, it helps in enhancing innovation and customer satisfaction of the organisation by providing adequate diversification in management (Froot et al. 2016, p. 354).
H. WACC / NPV of new aluminum smelting manufacturing plant in Vietnam
Assumptions for the calculations
• WACC for the non-domestic projects have been estimated to be 10 %. The project needs to be financed using 50 % debt and 50 % equity capital. Therefore, the WACC represents cost of 50 % debt and 50 % equity capital. WACC is computed by = Equity Cost x (Equity Capital / Summation of Capital Employed) + Preference Share Cost x (Preference Capital / Summation of Capital Employed) + Debts Cost x (Debts / Summation of Capital Employed) x (1- rate of tax)
• Depreciation will be charged at straight line method for the project.
• The projects require a time span of 5 years for full completion.
• Rate of inflation is 10 % at which cash inflow and cash outflow is increasing.
• Tax rate of 30 % has been assumed for all the projects.
• Terminal value will be calculated using after 5 year perpetual net operating cash flows.
• EBIT or Profit is the difference between cash inflow and cash outflow of the projects.
• All the cash inflows and cash outflows relate with the project and not the parent company.
• Cash outflow involves expenses related with depreciation, cost of materials, wages and salaries of the labour.
- New aluminum smelting manufacturing plant in the Vietnam
NPV = (Initial investment) + Money flow 1 / (1 + r) + Money flow 2 / (1 + r)2 + Money flow 3 / (1 + r)3 + Money flow 4 / (1 + r)4 + Money flow 5 / (1 + r)5
Net Present Value
Particulars Year 0 (in Millions) Year 1 (in Millions) Year 2 (in Millions) Year 3 (in Millions) Year 4 (in Millions) Year 5 (in Millions)
EBIT $ 45 $ 50 $ 55 $ 60 $ 115
(-): Taxes @ 30 % $ 13.50 $ 15 $ 16.50 $ 18 $ 34.50
(+): Depreciation $ 20 $ 20 $ 20 $ 20 $ 20
Net Operating Cash flow $ 51.50 $ 55 $ 58.50 $ 62 $ 100.50
(-): Changes in working capital $ (5) $ (4) $ (5.50) $ (2.50) $ (3)
Initial Investment $ (150)
Terminal Value $ 100
FCF $ (150) $ 56.50 $ 59 $ 64 $ 64.50 $ 203.50
WACC or Discount factor (10%) $ 1 $ 0.91 $ 0.83 $ 0.75 $ 0.68 $ 0.62
Present value of Cash Flow $ (150) $ 51.36 $ 48.76 $ 48.08 $ 44.05 $ 126.36
NPV $ 168.62
IRR 27 %
Table 1: NPV of aluminum smelting manufacturing plant Project
(Source: Created by Author)
Initial capital required for this project is $ 150 billion with estimated cash outflow of $ 25 Million in year 1, $ 24 Million in year 2, $ 25.5 Million in year 3, $ 22.5 Million in year 4 and $ 23 Million in year 5. On the other hand, profit includes $ 45 Million in year 1, $ 50 Million in year 2, $ 55 Million in year 3, $ 60 Million in year 4 and $ 65 Million in year 5. Value of assets at the end is $ 50 Million. Therefore, NPV of aluminum smelting manufacturing plant is $ 168.62 which is greater than $ 0 and indicates feasibility of investment. - Sensitivity analysis
As per the views of Marchioni & Magni (2018, p. 261), NPV is highly sensitive to certain factors due to which Sensitivity analysis is used. Sensitivity analysis can be performed for the project by adjusting discount rates or by changing cash flows as discussed below.
i. Adjusting discount rates: This can be done by incorporating foreign risks to the forecasted cash flow amount (Fagiolo et al. 2019, p. 763). An increase in discount rate causes NPV to decrease whereas a decrease in the cost of capital creates NPV to increase. Therefore, if WACC increases to 12% then the new NPV and IRR have been calculated below
Net Present Value
Particulars Year 0 (in Millions) Year 1 (in Millions) Year 2 (in Millions) Year 3 (in Millions) Year 4 (in Millions) Year 5 (in Millions)
EBIT $ 45 $ 50 $ 55 $ 60 $ 115
(-): Taxes @ 30 % $ 13.50 $ 15 $ 16.50 $ 18 $ 34.50
(+): Depreciation $ 20 $ 20 $ 20 $ 20 $ 20
Net Operating Cash flow $ 51.50 $ 55 $ 58.50 $ 62 $ 100.50
(-): Changes in working capital $ (5) $ (4) $ (5.50) $ (2.50) $ (3)
Initial Investment $ (150)
Terminal Value $ 100
FCF $ (150) $ 56.50 $ 59 $ 64 $ 64.50 $ 203.50
WACC or Discount factor (12 %) $ 1 $ 0.89 $ 0.80 $ 0.71 $ 0.64 $ 0.57
Present value of Cash Flow $ (150) $ 50.45 $ 47.03 $ 45.55 $ 40.99 $ 115.47
NPV $ 149.50
IRR 25 %
Table 2: Sensitivity analysis of aluminum smelting manufacturing plant Project
(Source: Created by Author)
Initial capital required for this project is $ 150 billion with estimated cash outflow of $ 25 Million in year 1, $ 24 Million in year 2, $ 25.5 Million in year 3, $ 22.5 Million in year 4 and $ 23 Million in year 5. On the other hand, profit includes $ 45 Million in year 1, $ 50 Million in year 2, $ 55 Million in year 3, $ 60 Million in year 4 and $ 65 Million in year 5. Value of assets at the end is $ 50 Million. Therefore, NPV of aluminum smelting manufacturing plant is $ 149.50 which is greater than $ 0 and indicates feasibility of investment. However, NPV & IRR of the project decreased.
ii. Changing cash flows: This can be done by increasing or decreasing cash flow of the projects. An increase in cash outflow causes NPV to decrease whereas a decrease creates NPV to increase (Obstfeld & Taylor, 2017). On the other hand, an increase in cash inflow causes NPV to rise whereas a decrease creates NPV to fall.
Net Present Value
Particulars Year 0 (in Millions) Year 1 (in Millions) Year 2 (in Millions) Year 3 (in Millions) Year 4 (in Millions) Year 5 (in Millions)
EBIT $ 40 $ 45 $ 50 $ 55 $ 110
(-): Taxes @ 30 % $ 12 $ 13.50 $ 15 $ 16.50 $ 33
(+): Depreciation $ 20 $ 20 $ 20 $ 20 $ 20
Net Operating Cash flow $ 48 $ 51.50 $ 55 $ 58.50 $ 97
(-): Changes in working capital $ (5) $ (4) $ (5.50) $ (2.50) $ (3)
Initial Investment $ (150)
Terminal Value $ 100
FCF $ (150) $ 53 $ 55.50 $ 60.50 $ 61 $ 200
WACC or Discount factor (12 %) $ 1 $ 0.89 $ 0.80 $ 0.71 $ 0.64 $ 0.57
Present value of Cash Flow $ (150) $ 47.32 $ 44.24 $ 43.06 $ 38.77 $ 113.49
NPV $ 136.88
IRR 22 %
Table 3: Sensitivity analysis of aluminum smelting manufacturing plant Project
(Source: Created by Author)
Initial capital required for this project is $ 150 billion with estimated cash outflow of $ 25 Million in year 1, $ 24 Million in year 2, $ 25.5 Million in year 3, $ 22.5 Million in year 4 and $ 23 Million in year 5. On the other hand, profit includes $ 40 Million in year 1, $ 45 Million in year 2, $ 50 Million in year 3, $ 55 Million in year 4 and $ 60 Million in year 5. Value of assets at the end is $ 50 Million. Therefore, NPV of aluminum smelting manufacturing plant is $ 136.88 which is greater than $ 0 and indicates feasibility of investment. However, NPV & IRR of the project decreased. - Scenario analysis
Based on the understanding of Mizgier (2017, p. 143), scenario analysis helps in determining different reinvestment rates for expected returns that are reinvested in the investment horizon. For instance, using the scenario analysis it can be said that after investing $ 150 aluminum smelting manufacturing plant project is being able to earn IRR of 27 %. However, if WACC increases to 12 % then the new NPV are $ 149.50 and IRR is 25 %. Similarly, if profit is decreased to $ 40 Million in year 1, $ 45 Million in year 2, $ 50 Million in year 3, $ 55 Million in year 4 and $ 60 Million in year 5, then NPV is $ 136.88 and IRR is 22 %. - Adjusting cash flows
Cash flow from the project has been adjusted for extra uncertainty of non-domestic products (Magni & Martin, 2017, p. 1). This includes factors such as inflation rates, changes in supply or demand and many more. - Real option
The real option facilitates the investors with the option to defer, to abandon, to alter capacity and to start up or shut down the project. In case if the investor find the selected project to be unachievable, then they can opt for shut down of the same or alter its capacity with others (Tadeu et al. 2016, p. 13). Therefore, this involves identification of major decision points.
Recommendation
• It is recommended to the firm to opt for FDI as a method of going international. With the help of FDI the manufacturing company will be able to construct a new aluminum smelting & manufacturing plant in Vietnam effectively. Therefore, the company will be using its funds to finance the project in Vietnam without any interference of third party.
• It is recommended to the firm to opt for loans from the financial institutions and commercial banks. It is known that financial institutions provide debts or loans to companies in foreign currency at a fixed rate of interest.
• In order to mitigate credit risk the business need to take payment in full. Taking payment in full reduces the risk of credit for the business. Moreover, letter of credit needs to be signed and issued through a financial institution. This provides with better authenticity and authorisation for the business in mitigating credit risk.
• In order to mitigate foreign exchange risk the business need to enter into futures and forwards. This helps the business in mitigating with the risk and take advantage of currency hedging.
• In order to mitigate shipping risk the business need to have sufficient support from third party. Moreover, agreement need to be made related with shipping quality and time for the business. This ensures proper shipment of the product to the destination.
Conclusion
It is essential for the organisation to enhance its NPV in order increase its performance and profitability. Thus, it means that New Zealand Aluminium Smelters project is the most profitable and feasible investment for a business. International capital budgeting includes generation of proposal includes origination of proposal for capital project for the firm at different levels of organisation operating in international markets. In addition to this, it helps the venture in allocating proposal of required project. It is necessary for the ventures operating in internal market so as to ensure higher profitability of organisation. Hence, efficient analysis of the project is essential in order to get adequate return from project. In the process of assessing the feasibility of project objectives and goals of the venture are compared to the project proposal in order to determine whether the project is efficient or not for the organisation. Further, it can be assessed that NPV is essential for the organisation for determining the present value of the investment. Further, international capital budgeting is that venture has ample of project proposal having similarities in return. So, it helps the process of capital budgeting in choosing adequate proposal by the venture. Besides this, NPV includes three main aspects such as NPV is greater than investment which indicates that investments must be selected. Thus, the NPV must be greater than the present value of investment in order to enhance the performance of organisation.
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