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$,t 
V  
t 
t 1  1  k  
n
• Where E(CF$,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 CFj ,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:

 E CFj,t xE(Sj , t )  •
V  

t
1  k   •
t 1 
n
•
•
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 MNC’s 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 oneyen gain in the Japanese
currency against the dollar
reduces Toyota’s 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%
+18.5%
+29.8%
+29.2%
+75.4%
+58.6%
-39.6%
-38.8%
-34.1%
- 7.1%
-27.4%
-42.9%
-45.3%
-58.7%
Exchange Rate Adjusted Equity
Returns in 2010
Period
Dec 31, 2009 –
Aug 18, 2010
Local Currency Return
Japan
United Kingdom
Canada
Germany
France
Czech Republic
Singapore
Malaysia
Hong Kong
-8.0%
-2.0%
+0.3%
+3.8%
-7.3%
+6.0%
+0.8%
+8.9%
-3.9%
Return in U.S. Dollars
+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
% Change
USD Return
Return*
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
Exchange Rate Adjusted
Returns on Government
Bonds, 2005