International Investment and Financing
International
International Investment and Financing
Syllabus tag: KASNEB CPA | Advanced Level | CA33 Advanced Financial Management | Topic 10 International Investment and Financing
Lesson objectives
By the end of this topic, you will be able to:
- Appraise a foreign project by forecasting exchange rates and converting
- Explain the difference between project and parent cash flows
- Identify and assess political risk
- Describe the sources of international finance
- Explain how transfer pricing is regulated
Why this matters
A foreign project adds two problems to an ordinary appraisal: the cash flows arrive in the wrong currency, and some of them may never reach the parent at all. Both change the answer.
Appraising a foreign project
The reliable method has three steps:
- Forecast the exchange rate for each year, usually by purchasing power parity
- Convert each year's foreign cash flow into shillings
- Discount the shilling flows at the parent's required rate
A project in the United States. Spot KES 150.00 per USD, Kenyan inflation 8%, US inflation 3%, discount rate 16%.
| Year | Rate (PPP) | USD flow | KES flow |
|---|---|---|---|
| 0 | 150.0000 | (2,000,000) | (300,000,000) |
| 1 | 157.2816 | 700,000 | 110,097,087 |
| 2 | 164.9166 | 800,000 | 131,933,255 |
| 3 | 172.9222 | 900,000 | 155,629,979 |
| 4 | 181.3165 | 600,000 | 108,789,914 |
NPV = KES 52,748,454
Note the shilling weakens each year under PPP because Kenyan inflation is the higher — which increases the shilling value of every dollar received. A candidate who uses the spot rate throughout will understate the NPV substantially.
The alternative method — discount the dollar flows at a dollar-adjusted rate, then convert the resulting NPV at spot — gives the same answer if the rates are consistent, and is harder to get right under examination conditions.
Project cash flows and parent cash flows
They are not the same, and the difference is the examinable point.
A project may generate cash that the parent never receives, because of:
- Withholding tax on dividends, interest and royalties remitted
- Exchange controls limiting or blocking remittance
- Additional taxation in the parent country on income received
- Local reinvestment requirements
The parent should appraise the cash flows it will actually receive. A project profitable in its own country and unable to remit anything is worth little to a Kenyan shareholder.
Where remittance is restricted, companies use royalties, management charges and interest on intra-group loans to extract value — which is precisely why those payments attract regulatory attention.
:::checkpoint A subsidiary generates USD 700,000 of distributable profit but withholding tax of 15% applies and half the remainder must be reinvested locally for three years. Compute what reaches the parent this year and explain the appraisal implication. :::
Political risk
Macro risk affects all foreign businesses in the country: expropriation, war, a change of government, currency inconvertibility.
Micro risk affects particular industries or firms: a change in mining royalties, local content rules, price controls on a specific sector.
Assessment uses country risk ratings, political stability indices and local advice — none of which is precise, which is why the response usually matters more than the measurement.
Managing political risk:
- Negotiate concession agreements in advance, fixing tax and remittance terms
- Take local partners, so that expropriation harms local interests too
- Finance locally, so that a seizure takes assets encumbered by local debt
- Control key inputs or technology from outside the country
- Insure through export credit agencies or political risk insurers
The common thread: make expropriation unattractive rather than merely unlawful. A government that seizes a plant it cannot operate, encumbered with debt owed to its own banks, has gained little.
Sources of international finance
| Source | Description |
|---|---|
| Eurobonds | Bonds issued outside the jurisdiction of the currency, often unsecured and in bearer form |
| Eurocurrency loans | Bank lending in a currency other than the lender's domestic one |
| Syndicated loans | Large facilities shared among several banks |
| Depositary receipts | Certificates representing shares in a foreign company, traded on a local exchange |
| Development finance | IFC, African Development Bank, bilateral agencies |
| Export credit | Government-supported finance for exporters |
Why borrow in a foreign currency: lower interest rates, access to deeper markets, and a natural hedge where the company has income in that currency.
Why not: the debt must be repaid in a currency the company does not control. A shilling depreciation raises the shilling cost of the debt without a further shilling being borrowed — which is the point in the CA26 public debt topic seen from the corporate side.
Matching is the discipline. Borrow in the currency in which income is earned, and the exposure largely disappears.
Transfer pricing
Prices charged between group companies in different countries affect where profit is reported and therefore where tax is paid.
The rule is the arm's length principle: transactions between related parties must be priced as they would be between independent ones.
Methods include comparable uncontrolled price, resale price, cost plus, transactional net margin and profit split.
Kenya requires transfer pricing documentation and adjusts profits where pricing is not at arm's length. The exposure is not only tax — a company can face adjustment in both countries, being taxed twice on the same profit, which is what double taxation agreements and advance pricing arrangements exist to prevent.
:::checkpoint A Kenyan subsidiary pays its foreign parent a management fee equal to 12% of turnover, with no evidence of services provided. Set out the risks under Kenyan tax rules and what documentation should exist. :::