– The process of deciding upon the financial viability of a foreign investment is the same as a domestic one; estimate expected cash flows and discount at the investment’s cost of capital.
– One important question is when currency translation should be done in the evaluation of an investment.
– Process is to use the interest rate structure of the foreign currency to estimate a risk-adjusted foreign currency discount rate, find the foreign currency NPV, and to translate the resulting foreign currency value at the spot exchange rate to find the domestic value for shareholders.
– Another issue is that of adjusting for the risks entailed in foreign investments per se. The tenets for financial managers to keep in mind are:
- Remember the benefits of diversification – if a company’s shareholders are not well diversified across international borders, a foreign investment may deserve a lower risk profile than a purely domestic one assuming the foreign investments cash flows are not well correlated with a comparable domestic one. If they are the consideration is neutral.
- Remember the relative uncertainties of the investment – alterations in foreign trade laws, exchange restrictions, asset confiscation, and friction repatriation can increase the risk of a foreign investment. A good analysis of these issues would wish to consider these relative to comparable domestic risks and add a foreign risk premium only if truly deserved.
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