Multinational Financial

Management (Cont.)
Lecture # 4
 Valuation Model for an MNC (1 of 6)

Domestic Model

V  
  E CF$,t  
 n
   

t 1  1  k 
t
 
Where
• V represents present value of expected cash flows
• E(CF$,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.

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 Valuation Model for an MNC (2 of 6)

Domestic Model (cont.)

• Dollar Cash Flows
• The dollar cash flows in period t represent funds received by the firm minus funds needed
to pay expenses or taxes or to reinvest in the firm.
• Cost of Capital
• The required rate of return (k) in the denominator of the valuation equation.
• A weighted average of the cost of capital based on all the firms projects.

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 Valuation Model for an MNC (3 of 6)

Multinational Modell

m
E CF$,t    E CF j ,t  E S j ,t   
j 1

Where
• CFj,t represents the amount of cash flow denominated
in a particular foreign currency j at the end of period t,

• Sj,t represents the exchange rate at which the foreign

currency (measured in dollars per unit of the foreign
currency) can be converted to dollars at the end of
period t.
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product or service or otherwise on a password-protected website for classroom use.
 Valuation Model for an MNC (4 of 6)

Multinational Model (cont.)

• Valuation of an MNC that uses two currencies
• Could measure its expected dollar cash flows in any period
by multiplying the expected cash flow in each currency by
the expected exchange rate at which that currency would be
converted to dollars and then summing those two products.
• Valuation of an MNC that uses multiple currencies

m
E CF$,t    E CF j ,t  E S j ,t   
j 1

• Derive an expected dollar cash flow value for each currency

• Combine the cash flows among currencies within a given period

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product or service or otherwise on a password-protected website for classroom use.
 EXAMPLE:

To the U.S parent, estimate the Austin’s cash flows. Austin Co. is a
U.S.-based MNC that sells video games to U.S. consumers; it also
has European subsidiaries that produce and sell the games in
Europe. The firm’s European earnings are denominated in euros (the
currency of most European countries), and these earnings are
typically remitted to the U.S. parent. Last year, Austin received $40
million in cash flows from its U.S. operations and 20 million euros
from its European operations. The euro was valued at $1.30 when
remitted year.
m
E CF$,t    E CF j ,t  E S j ,t   
j 1

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product or service or otherwise on a password-protected website for classroom use.
 Valuation Model for an MNC (5 of 6)

Multinational Model (cont.)

• Valuation of an MNC’s cash flows over multiple periods
• Apply single period process to all future periods
• Discount the estimated total dollar cash flow for each
period at the weighted cost of capital

 m 
n 

E CF j ,t  E S j ,t   
 j 1 
V   
t 1  1  k  t

 

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product or service or otherwise on a password-protected website for classroom use.
 Example:

Year
1 3362 2442 5.913 2871 3.138 2196 8.673 13.023
2 3537 4943 5.569 1697 3.497 2670 8.305 13.863
3 3290 3975 5.656 1707 3.739 2751 8.340 13.310

The table is representing the expected cash flows and exchange rate for each
parent (Domestic) and subsidiary (up to country 3) of a MNC. Find out:
1) Yearly total expected cash flow; and ii) Value of the firm at the end of year 3.

 m 
n 

E CF j ,t  E S j ,t   
 j 1 
V   
t 1  1  k  t

 

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product or service or otherwise on a password-protected website for classroom use.
 Valuation Model for an MNC (6 of 6)

Uncertainty Surrounding MNC Cash Flows (Exhibit 1.4)

• Exposure to international economic conditions — If economic conditions in a
foreign country weaken, purchase of products decline and MNC sales in that country
may be lower than expected. (Exhibit 1.5)
• Exposure to international political risk — A foreign government may increase taxes
or impose barriers on the MNC’s subsidiary.
• Exposure to exchange rate risk — If foreign currencies related to the MNC
subsidiary weaken against the U.S. dollar, the MNC will receive a lower amount of
dollar cash flows than was expected.
Summary of International Effects (Exhibit 1.4)

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product or service or otherwise on a password-protected website for classroom use.
Exhibit 1.4 How an MNC’s Valuation is
Exposed to Uncertainty

Assignment-I
3 Marks
Exhibit 1.5 Potential Effects of International Economic Conditions