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01 INBU 4200 Fall 2010 Lecture 1 Valuation Model for a MNC

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9 views14 pages

01 INBU 4200 Fall 2010 Lecture 1 Valuation Model for a MNC

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Akhilesh Suthar
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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
n
 E CF$,t 
V   t 
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
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,
• 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:
• Changes in foreign market conditions: Will

V  
n  
 E CFj ,t xE (Sj , t )  •
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

t 1  1  k   •
t 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 Yen in 2010
• 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 Toyota’s annual
operating profit by 30 billion
yen.
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 Local Currency Return Return in U.S. Dollars


2009
Japan +21.1% +18.5%
Germany +25.4% +29.8%
France +24.9% +29.2%
Australia +35.2% +75.4%
Canada +32.9% +58.6%

2008
Japan -39.6% -27.4%
Germany -38.8% -42.9%
Canada -34.1% -45.3%
Venezuela - 7.1% -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% +0.4%


United Kingdom -2.0% -5.4%
Canada +0.3% +1.9%
Germany +3.8% -7.0%
France -7.3% -17.0%
Czech Republic +6.0% +1.2%
Singapore +0.8% +4.7%
Malaysia +8.9% +18.1%
Hong Kong -3.9% -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%; HKD (Equity Market: -LC3.9%;
-$7.0% -$4.1% (a pegged currency)
Do Exchange Rates Affect Bond
Returns?
Exchange Rate Adjusted Bond
Returns
Return on German Bonds, 1994 -
1998
Exchange Rate Adjusted Returns on Government Bonds, 2005

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

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