What are the best practices for managing international capital budgets?

1 Adjust for inflation

One of the most important factors to consider when managing international capital budgets is inflation. Inflation is the general increase in the prices of goods and services over time, which reduces the purchasing power of money. Different countries have different inflation rates, which affect the value of their currencies and the cost of their projects. Therefore, when comparing the cash flows of different projects in different countries, you need to adjust them for inflation using a common currency and a common inflation rate. This will help you avoid overestimating or underestimating the profitability of your projects.

2 Consider exchange rate risk

Another factor to consider when managing international capital budgets is exchange rate risk. Exchange rate risk is the possibility that the value of your cash flows will change due to fluctuations in the exchange rates between different currencies. For example, if you invest in a project in a country whose currency depreciates against your home currency, you will receive less money when you convert your cash flows back to your home currency. This will reduce your return on investment and increase your risk. Therefore, when evaluating the cash flows of different projects in different countries, you need to consider the expected changes in the exchange rates and their impact on your cash flows. You can also use hedging strategies, such as forward contracts or options, to reduce or eliminate your exchange rate risk.

3 Account for political risk

A third factor to consider when managing international capital budgets is political risk. Political risk is the possibility that your cash flows will be affected by political events or changes in the host country, such as civil unrest, war, expropriation, nationalization, taxation, regulation, or corruption. These events or changes can disrupt your operations, increase your costs, reduce your revenues, or even result in the loss of your investment. Therefore, when assessing the cash flows of different projects in different countries, you need to account for the likelihood and severity of political risk and its impact on your cash flows. You can also use diversification strategies, such as investing in multiple countries or regions, to reduce your exposure to political risk.

4 Use appropriate discount rate

A fourth factor to consider when managing international capital budgets is the discount rate. The discount rate is the interest rate that you use to calculate the present value of your future cash flows. The discount rate reflects the opportunity cost of investing in a project, which is the return that you could earn by investing in an alternative project with similar risk and return characteristics. Different projects in different countries have different levels of risk and return, which require different discount rates. Therefore, when calculating the present value of your cash flows, you need to use an appropriate discount rate that matches the risk and return profile of your project. You can use various methods, such as the weighted average cost of capital (WACC), the capital asset pricing model (CAPM), or the international Fisher effect (IFE), to estimate the discount rate for your project.

5 Evaluate the net present value

A fifth factor to consider when managing international capital budgets is the net present value (NPV). The NPV is the difference between the present value of your cash inflows and the present value of your cash outflows. The NPV measures the profitability of your project, which is the amount of value that you create or destroy by investing in it. A positive NPV means that your project is profitable and adds value to your firm, while a negative NPV means that your project is unprofitable and destroys value for your firm. Therefore, when comparing different projects in different countries, you need to evaluate their NPV and select the one that has the highest positive NPV.

6 Review and revise

A sixth and final factor to consider when managing international capital budgets is the review and revision process. The review and revision process is the ongoing monitoring and evaluation of your projects and their performance. The review and revision process helps you identify and address any changes or deviations in your assumptions, expectations, or outcomes. The review and revision process also helps you learn from your experience and improve your decision making for future projects. Therefore, when managing international capital budgets, you need to review and revise your projects regularly and adjust them accordingly.

7 Here’s what else to consider

This is a space to share examples, stories, or insights that don’t fit into any of the previous sections. What else would you like to add?