Question Details

Santa Monica completed its capital budgeting analysis in August 



1. Accounting for Changes in Risk. Santa Monica Co., a U.S.-based MNC, was considering establishing a consumer products division in Germany, which would be financed by German banks. Santa Monica completed its capital budgeting analysis in August. Then, in November, the
government leadership stabilized and political conditions improved in Germany. In response,
Santa Monica increased its expected cash flows by 20 percent but did not adjust the discount rate
applied to the project. Should the discount rate be affected by the change in political conditions?
2. Estimating the NPV. Assume that a less developed country called LDC encourages direct foreign investment (DFI) in order to reduce its unemployment rate, currently at 15 percent. Also assume
that several MNCs are likely to consider DFI in this country. The inflation rate in recent years has
averaged 4 percent. The hourly wage in LDC for manufacturing work is the equivalent of about $5
per hour. When Piedmont Co. develops cash flow forecasts to perform a capital budgeting analysis
for a project in LDC, it assumes a wage rate of $5 in Year 1 and applies a 4 percent increase for
each of the next 10 years. The components produced are to be exported to Piedmont- headquarters in the United States, where they will be used in the production of computers. Do you
think Piedmont will overestimate or underestimate the net present value of this project? Why?
(Assume that LDC- currency is tied to the dollar and will remain that way.)




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