Question

political risks in capital budgeting and Starbucks

Answer 1

Political risk is a significant risk in capital budgeting, especially in cases of international capital budgeting. The global political structure and hence the regulatory mechanism are ever changing and dynamic in nature. This can change the underlying economic conditions that a company and its investments are exposed to and hence this changes the risks that its capital budgeting proposals and investments are exposed to.

Starbucks is a multinational corporation and outlets of Starbucks are present in several different countries like USA, Brazil, UK, India, Thailand, China, Malaysia, South Africa etc. The political regime and the regulatory regime in all these countries are not a fixed factor and will change after a pre-determined period. Such changes will change the factors affecting investment decisions of Starbucks. Economic variables like interest rates, inflation rates, forex rates, rate of GDP growth, employment growth and economic growth are affected by situations of political instability; regularly changing policies etc. will affect investment and expansion decisions of Starbucks. For example suppose that China is a prominent market for Starbucks and the company is looking to expand aggressively in the country. Suppose and assume that China is experiencing political instability and this will lead to shortening of policymakers’ horizons and hence sub-optimal short term macroeconomic policies will be made. This will make capital budgeting investments by Starbucks in China less attractive in the short term to medium term basis.