Evaluating the Impact Of Foreign Exchange Rate Risk On The Capital Budgeting For Multinational Firms

Abstract

Capital budgeting analysis has evolved to the point where large firms universally use sophisticated capital budgeting techniques.[1]  However, small firms are less likely to use sophisticated capital budgeting techniques.[2]  Even large firms do not generally use simulation for risk analysis in multinational project capital budgeting analysis.[3]  This paper provides a discussion and example of the use of simulation in evaluating the impact of foreign exchange rate volatility on multinational project capital budgeting analysis.

[1] Bierman, Harold, Jr. “Capital Budgeting in 1991:  A Survey,” Financial Management, Autumn 1993, pp. 21-29.

[2]  See, for example, Block, Stanley. “Integrating Traditional Capital Budgeting Concepts into an International Decision-Making Environment,” The Engineering Economist, 45(4), 2000, pp. 309-325 or Graham, John R. and Campbell R. Harvey.  “The Theory and Practice of Corporate Finance:  Evidence from the Field,” Journal of Financial Economics, 60, 2001, pp. 187-243.

[3] See, for example, Farragher, Edward, Robert Kleiman, and Anandi, Sahu.  “The Association Between the Use of Sophisticated Capital Budgeting Practices and Corporate Performance,” The Engineering Economist, 46(4), 2001, pp. 300-31, Ho, Simon S. M. and Richard H. Pike.  “Risk Analysis in Capital Budgeting Contexts:  Simple or Sophisticated?,” Accounting and Business Research, 21(83), 1991, pp. 227-238, Klammer, T. “Empirical Evidence of the Adoption of Sophisticated Capital Budgeting Techniques,” The Journal of Business, July 1972, pp. 387-397, and Klammer, T., B. Koch, and N. Wilner.  “Post-auditing Capital Assets and Firm Performance:  An Empirical Investigation,” Managerial and Decisions Economics, (12), 1991, pp. 317-327.