Valuation Models for a

MNC and a Global

Investor
Combined with Observations
on Exchange Rate Impacts

Objective of Lecture 1
In order to understand and appreciate the
international forces which multinational
firms and global investors face, we need
to develop valuation models for global
companies and investors.
The models which we will develop are
patterned after the Anglo-Saxon model of
corporate behavior and investment
valuations.

Valuation Concepts
Anglo-Saxon Approach:
Firm Evaluation: Consider the value of the firm
and corporate behavior in terms of
(maximizing) the market value of the firm for
shareholders.
Capital budgeting techniques evaluate projects and
corporate investments on the basis of present
value of their cash flows.

Financial Asset Evaluation: Consider the

present value of the anticipated future income
stream from a particular financial asset.

Anglo-Saxon Valuation Model

for Corporation: Present Value
of Future Cash Flow
E CF$,t

V
t 1

1 k

Where E(CF$,t) represents expected cash flows to be

received at the end of period t,
N represents the number of periods into the future
in which cash flows are received, and
K represents the required rate of return by investors.
Note: Changes in V occur because of changes in
E(CF$,t) and/or changes in K
4

Measuring the International

Cash Flows for a U.S. Based
MNC

E CF$,t E CF j ,t E S j ,t
m

j 1

Where CFj,t represents the amount of cash flow

denominated in a particular foreign currency j at
the end of period t,
Where Sj,t represents the exchange rate at which
the foreign currency can be converted into U.S.
dollars at the end of period t.
Measured in U.S. dollars per unit of the foreign currency.
5

Changes in the Value of a

MNC
Valuation Model V changes result from:

V
t 1

E CFj ,t xE (Sj , t )

1 k

Changes in foreign market conditions: Will

impact on foreign currency earnings and
thus on foreign currency cash flows (CF).
Changes in political environment and
political risk (policy of foreign government
towards MNC): Will impact on foreign
currency earnings and thus on foreign
currency cash flows (CF).
Changes in the MNCs cost of capital, i.e.,
the required return (k).
Changes in the exchange rate resulting
from exposure to exchange rate risk (S);
noting that:
Stronger foreign currency will increase U.S.
dollar equivalent of cash flows.
Weaker foreign currency will decrease U.S.
dollar equivalent of cash flows.

Exchange Rate Impacts on

Operating Profits
Japanese Multinationals
Sony, which generates
more than 70 percent of
revenue outside of Japan,
says it loses about 2 billion
yen of annual operating
profit for each yen gain
against the U.S. currency.
Toyota notes that every
one-yen gain in the
Japanese currency against
the dollar reduces Toyotas
annual operating profit by
30 billion yen.

Yen in 2010

Valuation Models for

Financial Assets
Bonds: Present value of:
Coupon payments + Par Value (face or
maturity value)
In U.S., par value = $1,000
Discount rate (k) is adjusted for opportunity cost and
risk adjustments.

Stocks: Present value of:

Future cash flow (Dividends, earnings)

Foreign currency denominated financial

assets: Valuation model adjustment needs
to be made for changes in exchange rates.

Do Exchange Rates Affect

Equity Returns?
For an investor in the United States investing foreign stock market:
Year
2009
Japan
Germany
France
Australia
Canada

2008
Japan
Germany
Canada
Venezuela

Local Currency Return Return in U.S. Dollars

+21.1%
+25.4%
+24.9%
+35.2%
+32.9%

-39.6%

+18.5%
+29.8%
+29.2%
+75.4%
+58.6%

-27.4%
-38.8%

-34.1%
- 7.1%

-42.9%
-45.3%
-58.7%

Exchange Rate Adjusted

Equity Returns in 2010
Period
Local Currency Return Return in U.S. Dollars
Dec 31, 2009
Aug 18, 2010
Japan
-8.0%
United Kingdom
-2.0%
Canada
+0.3%
Germany
+3.8%
France
-7.3%
Czech Republic +6.0%
Singapore
+0.8%
Malaysia
+8.9%
Hong Kong
-3.9%

+0.4%
-5.4%
+1.9%
-7.0%
-17.0%
+1.2%
+4.7%
+18.1%
-4.1%

Exchange Rates in 2010

JPY (Equity Market:
-LC8.0%; +$0.4%)

GBP (Equity Market: -LC2.0%;

-$5.4%)

Exchange Rates in 2010

EUR (German Equity Market:
+LC3.8%; -$7.0%

HKD (Equity Market: -LC3.9%;

-$4.1% (a pegged currency)

Do Exchange Rates Affect

Bond Returns?

Exchange Rate Adjusted

Bond Returns
Return on German
Bonds, 1994 - 1998
Year

Local
Market

Exchange Rate Adjusted Returns on Government Bonds, 2005

USD Return

Return*

% Change
in Local
Currency**

1994

-1.8%

11.8%

10.0%

1995

16.3%

9.6%

25.9%

1996

7.3%

-7.7%

-0.4%

1997

6.2%

-15.2%

-9.0%

1998

10.9%

8.9%

19.8%

1999

-2.1%

-14.3%

-16.4%

* = Interest (coupon payment) +/- Change in

market price
**1994 - 1998: % change in Deutschmark; 1999 %
change in Euro