FINS3616 · International Business Finance
Cost of Capital and International Capital Budgeting
Week 8 of UNSW FINS3616 teaches the cost of capital for foreign investment — segmented versus integrated markets, the international CAPM and a global WACC (Shapiro Ch 15) — then values a cross-border project with NPV/APV, handling parent-versus-project cash flows, blocked funds, tax and exchange-rate forecasts (Shapiro Ch 17). It combines discount-rate and cash-flow estimation into a full foreign-project valuation. Weeks 7–10 carry increased weight on the 40% final exam, making this the capstone quantitative chapter.
What this chapter covers
- 01WACC = (E/V)k_e + (D/V)k_d(1 − t); the discount rate should reflect the project's (not the parent's) systematic risk
- 02Cost of equity via CAPM: k_e = r_f + β × market risk premium; global vs local market portfolio under integration vs segmentation
- 03International diversification can lower a project's systematic risk (and required return) when returns are weakly correlated with the home/global market
- 04The adjusted-present-value (APV) approach: base-case value plus financing side-effects (tax shields, subsidised loans, blocked funds)
- 05NPV of a foreign project: NPV = Σ CF_t/(1+k)^t − I₀ on incremental after-tax cash flows
- 06Parent vs project cash flows: value from the parent's perspective — only repatriable cash flows create value
- 07Two equivalent valuation routes: discount FC cash flows at the foreign rate then convert the NPV at spot, OR convert each FC flow at expected future spot then discount at the home rate
- 08Adjustments: blocked funds, remittance restrictions, withholding taxes, inter-affiliate transfers, inflation consistency, terminal value
Full foreign-project valuation: WACC then NPV
- +1Compute the WACC: WACC = (E/V)k_e + (D/V)k_d(1 − t) = 0.60 × 12% + 0.40 × 6% × (1 − 0.25) = 7.20% + 0.40 × 4.5% = 7.20% + 1.80% = 9.0%.
- +1Set up the valuation: convert the foreign cash flows to home currency at expected future spot rates (from the parity conditions) — here already given in USD — and discount at the 9% WACC. (The equivalent route discounts the foreign-currency flows at a foreign rate then converts the NPV at spot.)
- +1Discount the home-currency flows: 4,000,000/1.09 + 5,000,000/1.09² + 6,000,000/1.09³ = 3,669,725 + 4,208,400 + 4,633,102 = $12,511,227.
- +1NPV = 12,511,227 − 10,000,000 = $2,511,227 > 0 → accept the project. But value only parent-repatriable cash flows: adjust for blocked funds, remittance limits and withholding tax before the final go/no-go.
Key terms
- WACC
- The weighted average cost of capital, WACC = (E/V)k_e + (D/V)k_d(1 − t), used to discount a project's cash flows. The tax shield applies only to debt, and the rate should reflect the project's own systematic risk, not the parent's average risk.
- Cost of equity (CAPM)
- k_e = r_f + β × market risk premium. For an international project the relevant β may be measured against a global market portfolio if markets are integrated, or against the local market if they are segmented.
- Integrated vs segmented markets
- In integrated capital markets risk is priced against a global portfolio, often giving a lower cost of capital; in segmented markets barriers force pricing against the local market, keeping the cost of capital higher. This choice drives which β and market premium enter CAPM.
- Adjusted present value (APV)
- A valuation that separates the base-case (all-equity) project value from financing side-effects — interest tax shields, subsidised loans, and the cost of blocked funds — valuing each piece at an appropriate rate and summing them.
- Parent vs project cash flows
- A foreign project is valued from the parent's perspective: only cash flows that can actually be repatriated create value. Blocked funds, remittance restrictions, withholding taxes and inter-affiliate transfers can make parent cash flows differ sharply from local project cash flows.
- Two valuation approaches
- Either (i) discount foreign-currency cash flows at the foreign discount rate and convert the resulting NPV to home currency at the spot rate, or (ii) convert each period's cash flow to home currency at expected future spot rates and discount at the home rate. Consistent parity assumptions make the two equivalent.
Cost of Capital and International Capital Budgeting FAQ
Why value a foreign project from the parent's perspective rather than the subsidiary's?
Because only cash that reaches the parent creates value for its shareholders. A subsidiary can look highly profitable locally, but if blocked funds, remittance restrictions or withholding taxes stop the cash from being repatriated, that profit does not benefit the parent. So you build the NPV on the incremental after-tax cash flows the parent can actually receive, adjusting for transfer restrictions and inter-affiliate flows. This parent-versus-project distinction is a favourite exam point and often flips a project from apparently positive to negative NPV.
What are the two equivalent ways to handle the currency in a foreign NPV?
Either discount the foreign-currency cash flows at a foreign-currency discount rate and then convert the single resulting NPV to home currency at today's spot rate; or convert each period's foreign-currency cash flow to home currency at the expected future spot rate (from interest rate parity / PPP) and discount those home-currency flows at a home-currency rate. If your exchange-rate forecasts and discount rates are built consistently with the parity conditions, both routes give the same NPV. Picking one and applying it cleanly avoids double-counting the currency effect.
How does market integration change the cost of capital for a foreign project?
In integrated markets, a project's risk is priced against a global market portfolio, so a project whose returns are weakly correlated with that global portfolio can have a low beta and therefore a lower required return — sometimes below a comparable domestic project. In segmented markets, barriers force pricing against the local market, which usually keeps the cost of capital higher. So whether you use a global or local beta and market risk premium in CAPM depends on the integration assumption, and it can materially change the discount rate and the NPV.
Can AI help me with cost of capital and international capital budgeting in FINS3616?
Yes. Sia is an AI tutor built to mirror how FINS3616 is taught and assessed at UNSW Sydney: it can walk you through a WACC build, a CAPM cost of equity, a full foreign-project NPV both ways, and the parent-versus-project cash-flow adjustments, one step at a time. It checks your reasoning but does not do graded assessment, and UNSW academic-integrity rules apply — this is the capstone quantitative chapter for the 40% final, so use it to rehearse.
Exam move
This is the capstone calculation chapter, so build one clean end-to-end procedure and rehearse it until it is automatic: compute the WACC (tax shield on debt only), estimate the project cash flows, handle the currency by ONE of the two consistent routes, discount, subtract the outlay, and state the decision. Then layer on the adjustments that the exam actually tests — value from the parent's perspective, strip out blocked and non-repatriable funds, apply withholding taxes — because these are where a naive NPV goes wrong. Keep the CAPM/integration point ready (global versus local beta and market premium) and know APV as the alternative that separates base-case value from financing side-effects. Verify your fluency by computing a foreign NPV both ways and confirming they match under consistent parity assumptions. Weeks 7–10 carry increased weight on the cumulative 40% final exam, and this chapter integrates the discount-rate and cash-flow strands, so practise a full valuation under timed conditions on the recorded tutorial questions. When a step won't click, ask Sia to re-run the valuation via the alternative currency route and reconcile the two.
Working through Cost of Capital and International Capital Budgeting in FINS3616? Sia is AskSia’s AI Business and Economics tutor — ask any FINS3616 Cost of Capital and International Capital Budgeting question and get a clear, step-by-step explanation grounded in how FINS3616 is taught and assessed. Read this chapter free, then take your hardest questions to Sia.
