Multinational capital budgeting bases foreign direct investment upon ownership, internalization, and locational advantages. These may be linked to a capital-budgeting analysis of an investment's cash flows and profitability. Volkswagen's recent investment in the U.S. is considered.
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References
1.
Firstly, to serve particular markets, the firm, in contrast to firms of other nationalities, must possess net-ownership-specific advantages. Given these advantages, it must be more beneficial to the firm to use them itself than to sell or lease them to other firms, and by extending its activities through foreign direct investment, the firm is able to internalize its ownership advantages. Such internalization can result from market failure or may represent a shield against market failure. The multinational replaces the market or augments it. Finally, if the above conditions are met, the firms will find it profitable to use these advantages only if the foreign location can offer certain resources that are not readily available in the home country. According to the eclectic theory, all forms of international production can be explained in terms of these three advantages. For a discussion of the eclectic theory, see DunningJohn H., “Trade, Location of Economic Activity and the Multinational Enterprise: A Search for an Eclectic Approach,” in OhlinB.HesselbornP.O.WiskmanP.J. (eds.), The International Allocation of Economic Activity (London: Macmillan, 1977); and DunningJohn H., “Changing Patterns of International Production: In Defense of the Eclectic Theory,”Oxford Bulletin of Economics and Statistics (November 1979), pp. 269–295. For a discussion of the theories of the multinational corporations, see the following: BuckleyP.J., “A Critical Review of Theories of the Multinational Enterprise,”Aussenwirtschaft, vol XXXVI, no. 1 (March 1981) pp. 70–87; HirschS., “An International Trade and Investment Theory of the Firm,”Oxford Economic Papers, vol. 28, no. 2 (July 1976), pp. 258–270; AgarwalJamuna P., “Determinants of Foreign Direct Investment,”Weltwirtschaftliches, vol. CXVI, no. 4 (1980), pp. 739–773; and CalvetA.L., “A Synthesis of Foreign Direct Investment Theories,”Journal of International Business Studies, vol. XII, no. 1 (Spring/Summer 1981), pp. 43–60.
2.
A more complete listing of these advantages can be found in Dunning, “Changing Patterns,” op. cit., p. 276.
3.
For a discussion of internalization theory and transfer pricing by the multinational corporation, see RugmanAlan M., “Internalization Theory and Corporate International Finance,”California Management Review, vol. XXIII, no. 2 (Winter 1980), pp. 73–79.
4.
StonehillArthurNathensonLeonard, in “Capital Budgeting and the Multinational Corporation,”California Management Review, vol. X, no. 4 (1968), pp. 39–54, attempted to present a better conceptual framework for evaluating foreign direct investment incorporating the net present value method (cash flow technique). It was argued that the criterion for the acceptance of the investment should be a positive net present value.
5.
The 6 percent rate was applied because it represented the cost of funds for borrowing by state governments when the investment decision was made.
6.
As indicated above, the profitability index, or the benefit/cost ratio as it is sometimes called, is obtained by dividing the present value of benefits by the initial year investment cost. The index shows the relative profitability of any project, or the present value of benefits per dollar of cost.
7.
Eiteman and Stonehill provide a clear discussion of why this approach is utilized in capital budgeting by multinational companies in Multinational Business Finance (Addison-Wesley, 1979), pp. 264–265.
8.
The subsidiary cost of capital was taken by weighing debt and equity capital .20-.80 and applying 9.0 percent and 13.8 percent cost of capital in each case. According to OblaskDavid J.HelmRoy J., in “Survey and Analysis of Capital Budgeting used by Multinationals,”Financial Management, vol. 9, no. 4 (Winter 1980), p. 39, this method (taking the weighted cost of capital) is employed most frequently to obtain the discount rate for foreign projects.
9.
The Volkswagen parent cost of capital is estimated at 14.0 percent for the capital-budgeting analysis summarized in Table 4.
10.
According to the 1977 Annual Report of Volkswagen Group, “A complex interchange of deliveries and services is practiced between various companies within the Group, in particular with regard to supply of finished products and production equipment”; p. 15.
11.
Concerning the minimizing of translation exposure, we should note that the West German parent company is not subject to accounting translation exposure requirements and standards such as FASB-8 in the United States, which applies to United States multinationals.
12.
It should be noted that on the basis of year-end exchange rates, the deutsche mark/dollar exchange rate moved as follows over the period 1975–79: 1975, DM 2.45 equal $1; 1976, DM 2.52 equal $1; 1977, DM 2.32 equal $1; 1978, DM 2.01 equal $1; 1979, DM 1.79 equal $1.
13.
The opportunity to shift profits from Latin America to the United States could increase if Volkswagen followed through with tentative plans to supply a greater share of parts and components from the Mexican subsidiary. BallRobert, “Volkswagen Hops Rabbit Back to Prosperity,”Fortune (13 August 1979), p. 124.
