Question

Should Investors Care about an MNC’s Translation Exposure?

POINT: No. The present value of an MNC’s cash flows is based on the cash flows that the parent receives. Any impact of the exchange rates on the financial statements is not important unless cash flows are affected. MNCs should focus their energy on assessing the exposure of their cash flows to exchange rate movements and should not be concerned with the exposure of their financial statements to exchange rate movements. Value is about cash flows, and investors focus on value. COUNTER-POINT: Investors do not have sufficient financial data to derive cash flows. They commonly use earnings as a base, and if earnings are distorted, so will be their estimates of cash flows. If they underestimate cash flows because of how exchange rates affected the reported earnings, they may underestimate the value of the MNC. Even if the value is corrected in the future once the market realizes how the earnings were distorted, some investors may have sold their stock by the time the correction occurs. Investors should be concerned about an MNC’s translation exposure. They should recognize that the earnings of MNCs with large translation exposure may be more distorted than the earnings of MNCs with low translation exposure. WHO IS CORRECT? Use the Internet to learn more about this issue.

Which argument do you support? WHY?

Answer 1

YES INVESTORS SHOULD CARE ABOUT MNC’s TRANSALATION  EXPOSURE

Translation exposure, a type of risk that occurs when an MNC translates its subsidiaries’ assets and liabilities from its host country currency to home country currency, can affect any company that operates in the foreign marketplace. This is especially an issue for large corporations such as Coca Cola, who deals with over a hundred operating currencies. When foreign exchange rates fluctuate, this has the capability of affecting the parent company’s financial assets. Thus, translation exposure is an important factor that investors should care about.

While translation exposure may not directly affect cash flows, it still has the potential to affect consolidated earnings and stock prices. For example, according to the Financial Academy of Financial Management, the Chief Executive of IBM in 1996 ended up declaring that their earnings in the second quarter would be reduced by $0.25 per share due to the impact of exchange rates on foreign earnings. Investors care greatly about a company’s earnings, and because an MNC’s translation exposure affects the company’s consolidated earnings, then the gains and losses that result from it should be taken into account. Being aware of translation exposure can ensure that businesses are better prepared for their operations and can better evaluate their future. Ignoring the risks associated with translation exposure does not eliminate them, and taking on a proactive management can help MNCs control their assets and protect investors.