Relevant calculations to FDI

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Relevant calculations to foreign direct investment
- Calculations relevant to a host government
- Calculations relevant to the firm investing

Calculations relevant to the host government

(Net benefit)/(Cost Ratio of FDI to the Host Country)

= [Payments to factors of production (Land, Labor, Capital) + Return/profit to management + Taxes paid to host country - Opportunity cost of using local factors of production + Sum of negative and positive externalities] / [Sum of payments to the foreign factors of production, including profits/dividends, interest, royalties, management fees]

(Benefit)/(Cost Ratio of Balance of Payments to Host Country)
= [Initial inflow of investment capital + Exports of the affiliate + Replacement of imports by the affiliate's output] /[Repatriated payments to other foreign factors of production + Imports by the affiliate + Imports induced by higher local income via the marginal propensity to import + Disinvestment of the affiliate]

Points of contention:
- The multinational enterprise and host country may employ different discount rates to the above listed cash streams --> the host country and MNE will have divergent perceptions of the benefit/cost ratio over time.

- The nominal market prices of inputs/outputs may need to be adjusted to reflect import restrictions, overvalued exchange rates & other market imperfections.

Calculations relevant to the firm investing

Project cash flow in local currency (in this case I use Euros and Rupees as my units):

[Sales - COGS - SGA - management fee - depreciation - cost of financing] x (1 - tax rate) + Depreciation - Change in WCR - Capex

In more detail:

[Sales Rs (t) - COGS coefficient x Sales Rs (t) x  [percent of locally produced inputs + percent of imported inputs x (1 + dummy variable 0 or 1 if there is a tax holiday at time t x (1 + change in spot rate Rs/Euros (t)]

- Coefficient of SGA expenses x Sales Rs (t)
- Coefficient of Management Fee x Sales Rs (t)
- Depreciation Rs (t)

-Interest Rs (t) x  Principal Rs (t) + interest Euros (t) x Principal Euros (t) x Spot rate Rs/Euros (t))] x (1-tax rate Rs (t) + Depreciation Rs (t) - Change in WCR Rs (t) - Capex Rs (t)

Parent's cash flow in reference currency:

Sum from t=1,T

[Project cash flows Rs (t) x percent share in project x ( 1 - Withholding tax Rs) x Spot rate Euros / Rs (t)] / (1 + cost of equity capital) ^ t

+

Sum from t=1,T
[Change in synergy Euros (t) + management fee x sales Rs (t) x Spot rate Euros / Rs (t) ]/ (1 + cost of equity capital) ^ t

+

(Terminal value Rs (T) x Spot rate Euros/Rs (T)) / (1 + cost of equity capital) ^ T

You would want to discount at the cost of equity to avoid the complications of discounting at the WACC which involves a number of tax rates imposed by the host country and the parent company's host country, which are likely to change, and also because the capital structure will change through the project's life time.

Cost of International Equity Capital