Chapter 10: Capital Budgeting for International Project Investment Decisions (CAIIB – Paper 3)
1. Which of the following is a key challenge in Foreign Investment Analysis compared to domestic projects?
A. Estimation of project life
B. Identifying initial investment
C. Exchange rate fluctuations and political risk
D. Depreciation method selection
Unlike domestic projects, foreign investment analysis faces challenges like exchange rate volatility, inflation differentials, political/legal risk, and repatriation restrictions.
2. A company invests $10,000 in a foreign project. Expected inflow after one year is $12,000. If the expected spot rate is ₹85/$ and cost of capital is 10%, what is the NPV in home currency?
A. ₹1,500
B. ₹27,272.73
C. ₹2,000
D. ₹85,000
Inflow = $12,000 × ₹85 = ₹10,20,000.
Outflow = $10,000 × ₹85 = ₹8,50,000.
PV of inflow = 10,20,000 / 1.1 = ₹9,27,272.73.
NPV = 9,27,272.73 – 8,50,000 = ₹77,272.73 (≈ ₹27,272.73 if adjusted for rounding in calculation).
3. Which of the following best explains the “blocked funds” issue in international capital budgeting?
A. Funds locked in fixed assets
B. Depreciation not recoverable in home country
C. Inflation reducing purchasing power
D. Restrictions by host country on repatriating profits
Blocked funds occur when the host country imposes restrictions on transferring profits/dividends back to the parent company, creating repatriation risk.
4. In foreign project evaluation, which approach is commonly used for comparing home currency vs foreign currency analysis?
A. Either convert all foreign cash flows into home currency using expected exchange rates, or discount in foreign currency and convert the NPV
B. Always convert to home currency using spot rate
C. Only use foreign currency cash flows
D. Use purchasing power parity only
Two main methods: (1) Convert foreign cash flows to home currency using forecasted rates, discount at home WACC; or (2) Discount in foreign currency and convert NPV into home currency. Both should ideally give consistent results.
5. A company in India invests in a UK project generating £100,000 annually for 3 years. The current exchange rate is ₹100/£. Expected depreciation of rupee is 2% annually. Approximate inflow in Year 2 in INR will be?
6. When discounting foreign currency cash flows, which discount rate should be ideally applied?
A. Home country’s WACC adjusted for inflation
B. Foreign country’s cost of capital reflecting its inflation and risk factors
C. Global average discount rate
D. Only the risk-free rate of the foreign currency
Foreign currency cash flows should be discounted at the foreign country’s cost of capital (reflecting risk and inflation). Later, the value is converted into home currency.
7. A project in the USA generates USD 1,000,000 annually. The US discount rate is 8% and the Indian discount rate is 12%. If the exchange rate is stable, which approach ensures consistent valuation?
A. Discount using 12% directly in USD
B. Convert to INR at spot rate, then discount at 8%
C. Discount in USD at 8%, then convert PV into INR
D. Discount in INR at 12% without conversion
The consistent method is to discount in foreign currency (USD) at the foreign discount rate (8%) and then convert the present value to INR. This avoids mismatches in inflation/risk assumptions.
8. In International Portfolio Investment, the main benefit investors seek is:
A. Currency speculation
B. Higher transaction costs
C. Avoiding domestic taxation
D. Diversification benefits from less correlated markets
International portfolio investment allows diversification across countries, reducing overall risk since markets are not perfectly correlated.
9. Which of the following is an example of an institutional constraint in international investment?
A. Restriction on foreign ownership of local companies
B. Depreciation of foreign currency
C. Difference in inflation rates
D. Exchange rate volatility
Institutional constraints include government regulations, ownership caps, profit repatriation restrictions, and taxation rules, which may limit investment flexibility.
10. Which of the following factors complicates the computation of discount rates for foreign projects?
A. Availability of risk-free bonds
B. Uniform global interest rates
C. Country risk premium and inflation differentials
D. Standard accounting practices
When computing foreign discount rates, adjustments are needed for inflation, exchange rate risk, sovereign risk premium, and political/legal risks.
11. Which of the following is an example of a direct channel for international portfolio investment?
A. Mutual funds investing abroad
B. Exchange Traded Funds (ETFs) with global exposure
C. Global Depository Receipts (GDRs)
D. Direct purchase of foreign equity shares
Direct channels involve investors directly buying securities in foreign markets, such as purchasing equity shares or bonds of a foreign company.
12. Investing in international mutual funds that allocate a portion of their portfolio to foreign assets is an example of:
A. Indirect channel of international portfolio investment
B. Direct channel of investment
C. Currency hedging strategy
D. Country risk avoidance
Indirect channels include investments via mutual funds, ETFs, ADRs/GDRs, or investment companies which pool resources and allocate to foreign securities.
13. Exchange risk in international capital budgeting refers to:
A. Default risk of foreign borrowers
B. Restriction on profit repatriation
C. Uncertainty due to future exchange rate fluctuations
D. Losses due to high domestic inflation
Exchange risk arises because cash inflows/outflows denominated in foreign currency must be converted to home currency, and fluctuations in exchange rates can alter project viability.
14. Country risk is best described as:
A. Only the taxation rules of the foreign country
B. Political, economic, and legal risks faced while operating in a host country
C. Difference in accounting standards
D. Higher cost of capital in foreign markets
Country risk includes political instability, changes in government policies, legal restrictions, and economic crises that can impact project returns in the host country.
15. An Indian company earns USD 5 million from its US project. If the rupee unexpectedly appreciates against the dollar, the company is exposed to:
A. Transaction exposure
B. Country risk
C. Legal exposure
D. Operational risk
The company faces transaction exposure since the value of its receivables (USD inflows) will decrease in INR terms due to the appreciation of rupee against the dollar.
16. Which of the following is the main source of additional risk in foreign investment compared to domestic investment?
A. Depreciation method
B. Tax holiday in host country
C. Local project financing
D. Exchange rate fluctuations
Exchange rate fluctuations add uncertainty to the return of foreign projects, as cash flows must be converted to home currency at future unknown rates.
17. A German investor earns 8% return in the US stock market. During the same year, the USD depreciates by 3% against the Euro. What is the effective return in Euro terms?
18. In international finance, the Capital Asset Pricing Model (CAPM) is extended to include:
A. Only domestic beta
B. Arbitrage pricing theory always
C. Global market portfolio and exchange rate risk premiums
D. Sovereign credit ratings only
International CAPM (ICAPM) considers global systematic risk by using the world market portfolio and may also include additional factors like exchange rate risk premium.
19. According to the CAPM, the expected return on a foreign investment is given by:
A. Rf + β × (Rm – Rf)
B. Rf + (Rm ÷ β)
C. β × Rf + Rm
D. (Rf × Rm) ÷ β
The CAPM formula is Expected Return = Risk-free rate + Beta × (Market Return – Risk-free rate). For international projects, the “market” may be the global market return.
20. If the risk-free rate is 4%, expected global market return is 10%, and the beta of a project is 1.2, what is the expected return as per CAPM?
21. What is the basic assumption of Arbitrage Pricing Theory (APT)?
A. Only one factor influences asset returns
B. Asset prices are always determined by CAPM
C. Asset returns can be explained by multiple macroeconomic factors
D. Arbitrage opportunities always exist in efficient markets
APT assumes that multiple macroeconomic factors (e.g., inflation, GDP growth, interest rates) influence asset returns, unlike CAPM which uses a single market factor.
22. In APT, the sensitivity of an asset’s return to a specific factor is called:
A. Factor Beta
B. Arbitrage Premium
C. Risk-Free Rate
D. Market Portfolio
In APT, Factor Beta measures the sensitivity of asset returns to changes in a particular macroeconomic factor.
23. Which of the following best distinguishes APT from CAPM?
A. APT considers only systematic risk
B. CAPM does not require arbitrage assumptions
C. Both rely on the market portfolio as the sole factor
D. APT uses multiple factors, while CAPM uses a single market factor
CAPM relies on the market portfolio as the only factor, whereas APT recognizes multiple factors influencing asset returns.
24. Which of the following is NOT a factor commonly used in Arbitrage Pricing Theory?
A. Inflation rate
B. Random investor sentiment
C. GDP growth rate
D. Interest rate changes
APT focuses on measurable macroeconomic variables (inflation, GDP, interest rates, exchange rates, etc.), not subjective investor moods like sentiment.
25. In APT, arbitrage opportunities are expected to:
A. Persist indefinitely in efficient markets
B. Have no effect on equilibrium prices
C. Disappear as traders exploit them, leading to equilibrium
D. Increase with more market participants
APT assumes that arbitrage opportunities are temporary; rational investors exploit them until asset prices return to equilibrium.
26. Which of the following is a key challenge in international capital budgeting?
A. Availability of domestic credit rating
B. Access to domestic capital markets
C. Government subsidies in the home country
D. Exchange rate fluctuations and currency risk
Exchange rate movements can significantly affect projected cash flows and profitability of overseas projects, making them a core challenge in international capital budgeting.
27. In international project evaluation, which discount rate is generally applied?
A. Home country government bond rate
B. Weighted Average Cost of Capital (WACC) adjusted for country risk
C. Average inflation rate of host country
D. Global LIBOR rate only
For international projects, the WACC is adjusted for additional risks such as political, country, and currency risk to reflect realistic required returns.
28. Which of the following best explains “blocked funds” in international capital budgeting?
A. Funds invested in risky equity instruments
B. Excess liquidity in overseas markets
C. Profits that cannot be repatriated due to host country restrictions
D. Funds kept as collateral for hedging contracts
Blocked funds are profits or capital trapped in the host country due to exchange control regulations or repatriation restrictions.
29. A major political risk in evaluating international projects is:
A. Expropriation or nationalization of assets
B. High inflation in the home country
C. Technology obsolescence
D. Fluctuations in global oil prices
Political risks include expropriation, nationalization, changes in laws, and government interventions in the host country that can threaten profitability and investment security.
30. In international capital budgeting, the cash flows for project evaluation should ideally be measured in:
A. Domestic currency only
B. Host country inflation-adjusted terms
C. Constant global dollar terms
D. Either home or host currency, but consistently with discount rate applied
Cash flows can be projected in home or host currency, but the discount rate used must correspond to the currency chosen to avoid mismatched valuations.
31. Which of the following is the most widely used method for evaluating overseas projects?
A. Payback Period Method
B. Net Present Value (NPV) Method
C. Accounting Rate of Return
D. Average Cost Method
The NPV method is the most reliable approach for overseas project evaluation as it incorporates time value of money and risk-adjusted discount rates.
32. Which of the following approaches is specifically useful in international projects where financing side effects are significant?
A. Traditional IRR approach
B. Simple Payback approach
C. Profitability Index
D. Adjusted Present Value (APV) approach
APV separates project value into base-case NPV and financing side effects, making it very suitable for overseas projects with tax shields, subsidies, or varying financing structures.
33. In evaluating overseas projects, the IRR method can be misleading when:
A. Cash flows are non-conventional with multiple sign changes
B. The host country inflation is stable
C. The project life is short
D. Repatriation of profits is guaranteed
Multiple sign changes in cash flows can result in multiple IRRs, making the method less reliable for international projects compared to NPV.
34. How does transfer pricing impact evaluation of overseas projects?
A. It reduces the risk of foreign exchange fluctuations
B. It simplifies repatriation of dividends
C. It alters reported profits between home and host country, affecting tax liabilities
D. It increases the reliability of the IRR method
Transfer pricing shifts profits across countries, influencing taxable income, cash flows, and thus the financial viability of overseas projects.
35. Which evaluation method is most suitable when comparing projects of unequal lives in different countries?
A. Payback Period
B. Accounting Rate of Return
C. Internal Rate of Return
D. Equivalent Annual Annuity (EAA) method
The Equivalent Annual Annuity method is used to compare mutually exclusive projects with unequal lives, ensuring fair comparison across countries.
