Explain the difference between working capital and net working capital, and discuss why managers employ net present value (NPV) analysis to evaluate domestic and international capital investment projects

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Working capital refers to the current assets of a company. Net working capital is the difference between current assets and current liabilities. As part of working capital management, firms manage all current accounts, such as cash, accounts receivable, inventory, and accounts payable. Cash comes from various sources, especially sales of goods and services. In the MNE, an important task of working capital management is ensuring cash is available where and when needed. Cash-flow needs arise from everyday activities, such as buying labor and materials, paying interest on debt, and paying taxes and shareholder dividends. To optimize global operations, international finance managers devise strategies for transferring funds among the firm's operations worldwide.
Managers typically employ net present value (NPV) analysis to evaluate domestic and international capital investment projects. NPV is the difference between the present value of a project's incremental cash flows and its initial investment requirement. Four considerations complicate international capital budgeting for an MNE. First, project cash flows are usually in a currency other than the reporting currency of the parent firm. Second, tax rules in the project location and the parent's country usually differ. Third, governments may limit the transfer of funds from the project to the parent firm. Finally, the project may be exposed to country risk, such as government intervention, high inflation, or adverse exchange rates.
Managers employing NPV address these in two ways. One is to estimate the incremental after-tax operating cash flows in the subsidiary's local currency and then discount them at the project's cost of capital, or required rate of return, appropriate for its risk characteristics. If the NPV is positive, the project is expected to earn its required return and add value to the subsidiary. This approach takes the project's perspective in capital budgeting, and managers can use it as a first screening method.
The second approach, called the parent's perspective, estimates future cash flows from the project in the functional currency of the parent-that is, the currency of the primary economic environment in which it operates. Thus, U.S.-based firms' functional currency is the U.S. dollar; for Japan-based firms it is the yen. This conversion forecasts spot exchange rates, or forward rates, and calculates their present value using a discount rate in line with the required return on projects of similar risk. Managers then compute the NPV in the parent's functional currency by subtracting the initial investment cash flow from the present value of the project cash flows. To be acceptable the project must add value to the parent company; it should therefore have positive NPV from the parent's perspective.