Question

Discuss the difference between performing the capital budgeting analysis from the parent firm’s perspective as opposed to the project perspective.

Answer 1

Answer: The goal of the financial manager of the parent firm is to maximize its shareholders’ wealth. Acapital project of a subsidiary of the parent may have a positive NPV (or APV) from the subsidiary’sperspective yet have a negative NPV (or APV) from the parent’s perspective if certain cash flows cannotbe repatriated to the parent because of remittance restrictions by the host country, or if the home currencyis expected to appreciate substantially over the life of the project, yielding unattractive cash flows whenconverted into the home currency of the parent. Additionally, a higher tax rate in the home country maycause the project to be unprofitable from the parent’s perspective. Any of these reasons could result inthe project being unattractive to the parent and the parent’s stockholders.