Cross Border Valuation

Question 1

Apart from investment and financing decisions, what additional issues are raised by the analysis of a foreign project?

Answer 1

1. Should cash flows be measured from the point of view of the project or that of the parent?
2. Should the additional economic and political risks that are uniquely foreign be reflected in cash-flow or discount rate?

Question 2

Which cash-flows should the parent MNC value?

Answer 2

Cash flows that are, or can be, repatriated net of any transfer cost (such as taxes) because only accessible funds can be used for the payment of dividends and interest, for amortisation of the firm’s debt, and for reinvestment.

Question 3

What is the forward-rate method?

Answer 3

A two-stage approach to calculate the PV(FCF) from a foreign project:
1. Convert nominal foreign currency FCF into nominal home currency terms.
2. Discount those nominal FCF at the nominal domestic/home required rate of return.

Question 4

True or false: depreciation tax shields rise with inflation.

Answer 4

False

Question 5

True or false: revenues and variable costs increase in line with inflation

Answer 5

True

Question 6

How can we correct the effects of for example depreciation tax shields will not rise with inflation, whereas revenues and variables costs are likely to increase in line with inflation?

Answer 6

In practice, correcting these effects means first adjusting the foreign currency cash flows for inflation and then converting the project FCF back into the home currency using the forecast exchange rate.

Question 7

How can we convert the FCF from the local currency to the home currency?

Answer 7

In order to convert the FCF from the local currency to the home currency, we should use the expected spot rate for the respective point in time.

Question 8

How can we estimate future spot rates?

Answer 8

In most cases, to estimate future spot rates we use the current forward rates because, if the International Fisher Effect holds true, the expected future spot exchange rate equals the today forward rate.

Question 9

True or false: if the forward rate isn’t observed, we can’t synthesise it.

Answer 9

False

Question 10

What kinds of risk can a subsidiary firm face that are completely different from the parent company?

Answer 10

• Economic Risk
• Political Risk
• Foreign-Investment Risk
• Foreign-Currency Risk

Question 11

What is the general approach for incorporating risks in an investment analysis?

Answer 11

It usually involves adjusting the FCF of the project to incorporate the impact of a particular political event, rather than adjustments in the discount rate.

Question 12

What is expropriation?

Answer 12

Expropriation happens where the project and parent FCF diverge. The proposed approach is to examine the impact of the expropriation on the present value of the project to the parent.

Question 13

What happens when all funds are expected to be blocked in perpetuity?

Answer 13

The NPV of the project is 0.