Evaluating Foreign Direct Investment Projects

As explained in the foregoing chapter, once the relevant cash outflows and inflows associated with a foreign direct investment project are estimated so as to calculate the net cash flows, the desirability of the investment project should then be determined in terms of its economic profitability. Therefore, in this chapter the methods widely used in evaluating investment projects are discussed and their advantages as well as shortcomings are highlighted. Later in the chapter, evaluating foreign direct investment projects from the viewpoint of the parent company is elaborated in terms of profit and/or income transferred to the home country. The same investment evaluation techniques were applied to the net cash flows transferred to the home country of the parent company. The possible income and/or dividends to be remitted to the home country of a parent company are identified and discussed so as to reflect the viewpoints of investing parent companies when planning foreign direct investments. This two-level evaluation approach is generally followed in practice to make sure that direct investments are profitable at both host and home country levels, since an investment project that is not profitable at host country level would not be profitable at home country level either or a project that is profitable at host country level may not be profitable at home country level.

Financial Analysis

The market and technical analyses aim at finding out whether or not the conceived product of the investment project is marketable and that its production is technically feasible. If the product is marketable and the investment project is technically feasible, then a detailed financial analysis is required. The basic purpose of the financial analysis as the final stage of a feasibility study is three fold: (1) to compute the total amount of the investment needed for realizing the project and decide how it would be financed, (2) to estimate the total amount of annual manufacturing costs for the production process as well as the total amount of annual sales revenues expected during the operating period, and (3) to evaluate the profitability of the investment on the basis of the costs and sales revenues associated with the investment project. If the investment project is profitable, then a risk analysis is conducted to evaluate its riskiness so as to decide about its desirability. Accordingly, the financial analysis stage is the backbone of this book. However, a chapter that would include these three subjects must necessarily to be very large in size and complicated in content. Therefore, in order to prevent this complication and provide a clear theoretical explanation for the final stage of a feasibility study, the financial analysis stage is divided into three consecutive and complimentary chapters on the basis of the objectives stated above. Thus, this chapter is confined to the first objective in the sense of computing the total amount of investment in terms of the fixed capital (fixed costs) and the working capital, determining sources of financing, and estimating annual operating expenditures and expected sales revenues.

Technical Analysis

A comprehensive feasibility study should continue with a technical analysis if the market analysis, as explained in the chapter, defines a sufficiently large market share for the product to be manufactured through a foreign direct investment project. The technical analysis as the second stage of a feasibility study aims at determining whether or not the production of the marketable product is technically feasible in terms of what the production technology will be, how the production process is to be designed, and where the production site would be located in the country selected. This chapter covers topics and discussions about technical aspects of establishing a production facility. Thus, it answers the question of whether the production of a product that is determined to be marketable is technically possible and, if so, how the production facility should be designed. If the investment project is technically feasible, then an implementation plan through project programing techniques of network analysis is developed for both estimating the total cost of fixed investment and planning the establishment of the plant or factory required. Thus, at the end of the technical analysis stage, the use of project programing techniques is explained for planning the implementation of an investment project.

Risk Analysis in Project Evaluation

This final chapter is devoted to the analysis of the risks associated with foreign direct investments, namely business (commercial) risk, political risk, and currency exchange rate risk. Each risk factor is considered as a separate evaluation criterion. That is, an investment project may be rejected due to having a high level of any one of these three risk factors. For instance, a profitable investment proposal may not have a significant business risk but might have a high level of political risk requiring its rejection. Risk analysis is conducted only if a foreign investment project is profitable from the viewpoint of the parent company. Otherwise, there is no need for a risk analysis since a direct investment project that does not create profit for the parent company would be rejected anyway.

Planning Foreign Direct Investment Projects

This chapter develops a framework for the whole book and defines a road map for the chapters that follow it. However, in order to follow the road map or to go through the stages of analyses defined for a comprehensive economic study called a feasibility study for an investment project, the starting point is to select a country for the foreign direct investment contemplated. Therefore, country selection is the first step for starting a comprehensive economic study for planning and analyzing foreign direct investments. For this reason, before starting to plan, analyze, and evaluate a foreign direct investment, a country has to be determined for the direct investment project intended. As such, factors affecting country selection in terms of opportunities and risks related to alternative countries are specified and elaborated first and then put together in an example to develop a methodology for selecting a host country for the direct investment planned abroad. Country selection is based on a procedural methodology that goes through, firstly, a scanning stage that aims at identifying possible countries for investment; secondly, eliminating less desirable countries for determining possible candidates; and finally, choosing the most adequate country for investment through a so-called opportunity-risk matrix.

Conceptual Basis of International Investments

This chapter provides a theoretical background for international investments in general. However, before going into the conceptual details of international investments, the concept of investment in general is clarified with respect to national economies in terms of financial and real capital or fixed investments. From the viewpoint of investors' objectives of controlling the investment area, international investments are classified in two general categories: international portfolio investments and foreign direct investments. In order to complete the conceptual basis of international investments, the theoretical aspects of foreign direct investments as the main subject of this book are discussed so as to establish a theoretical background for the book. Therefore, upon describing various forms of foreign direct investments, the reasons for international investors to invest abroad as well as the advantages of direct investments for host countries are expounded to give the reader a holistic picture about the importance of foreign direct investments for both international investors and host countries. Eventually, the traditional political critiques of international investment are given to cover all pros and cons of international investments in general and foreign direct investments specifically. Finally, the essential reasons for conducting a comprehensive feasibility study for planning and analyzing foreign direct investments are discussed in order to expound the significance of this book.

Market Analysis

The chapter is devoted to the market analysis as the first stage of the methodology proposed for planning and analyzing foreign direct investments. The market analysis that precedes technical and financial analyses stages of the comprehensive economic study for planning and analyzing foreign direct investments aims at determining whether or not the market for a direct investment project is large enough. Therefore, all studies, work, and activities involved in the market analysis stage as explained in the chapter are confined to determining whether or not the target market for the product to be manufactured through a foreign direct investment is sufficient enough. For this purpose, the essential points to be considered for analyzing the competitive market environment in terms of demand and supply conditions of the market as well as purchasing behavior of consumers are explained step by step. Finally, how a marketing strategy could be developed on the basis of the information regarding the demand and supply sides of the target market is discussed that what possible market share might be captured is elaborated as the final point of the market analysis.