For a project of longer life, even if cash flows are blocked for the first few years, the remaining
years’ cash flows can contribute to the parent’s returns and NPV.
Finally, there is the issue of risk attached to international cash flows. The
three basic types of risks are (1) business and financial risks, (2) inflation and
exchange rate risks, and (3) political risks. The first category reflects the type of
industry the subsidiary is in as well as its financial structure. We will present more
details on financial risks later. As for the other two categories, we have already
discussed the risks of having investments, profits, and assets/liabilities in different
currencies and the potential impacts of political risks.
The presence of the three types of risks will influence the discount rate to be
used when evaluating international cash flows. The basic rule is this: The local
cost of equity capital (applicable to the local business and financial environments
within which a subsidiary operates) is the starting discount rate. To this rate, the
MNC would add the risks stemming from exchange rate and political factors,
and from it, would subtract the benefits reflecting the parent’s lower capital costs.