Question Details

How can you use capital budgeting to conduct your comparison



One of the best methods of learning broad concepts in this text is to put yourself in the place of an
MNC manager or board member, and apply the concepts to make financial decisions. Board members
do not normally make the decisions that are discussed here, but must have the conceptual skills to
monitor the policies that are implemented by the MNC- managers. Thus, they must frequently ask
themselves what they would do if they were making the managerial decisions or setting corporate
polices.
Consider the following business that you could easily create: a business that teaches individuals in a
non-U.S. country to speak English. While this business is very basic, it still requires the same type of
decisions faced by large MNCs. Assume that you initially establish this business in Mexico.
Details of Your Business. You live in the U.S. You invested $60,000 to establish a business of a
language school called EE (Escuela de Engles) in Mexico City, Mexico. You hire local individuals in
Mexico who can speak English and train others how to speak English. You have a small subsidiary in
Mexico, which has an office and an attached classroom that you lease. Clients can come to your
subsidiary for a 1-month structured course in English, taught by your employees. You advertise in the
local newspapers to promote the teaching services offered by your business.
You also serve some individuals from Mexico who have taken English classes and want to come to the
U.S. for a one-week intense course in which they can improve and practice their English and practice
it. All revenue and expenses associated with your business are denominated in Mexican pesos. Most of
the profits from the business in Mexico are sent to you by your subsidiary at the end of each month.
While your expenses are somewhat stable, your revenue varies with the number of clients who sign up
for the English-speaking courses in Mexico.
You only need to know this background so that you can answer the related questions that are asked
about your business throughout the term. Answer each question as if you were serving on the board of
your business or as a manager of the business. The questions in the early chapters force you to assess
the firm- opportunities and exposure, while the later chapters force you to offer your input on
potential strategies that your business may pursue.
1.
a. Assume that your business is considering expansion within Mexico. You plan to invest a small
amount of U.S. dollar equity into this project, and finance the remainder with debt. You can
obtain debt financing for the expansion in Mexico, but the interest rates in Mexico are higher
than in the U.S. Yet, if you used mostly U.S. debt financing, you are more exposed to
exchange rate risk. Explain why.
b. If you pursue a new project in Mexico, you want to assess the feasibility of the project if you
use mostly U.S. debt financing, versus mostly Mexican debt financing. Yet, you also want to
capture possible exchange rate effects on your cash flows over time. How can you use capital budgeting to conduct your comparison?
c. You would prefer to avoid using Mexican debt to finance your expansion in Mexico because
the interest rates are high. A consultant suggests that you seek one or more investors in
Mexico who would be willing to take an equity position in your business. You would provide
them with periodic dividends and they would be partial owners of your company. The
consultant suggests that this strategy circumvents the high cost of capital in Mexico because it
uses equity financing instead of debt financing. Is the consultant correct?




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