Question

Please Explain the Valuation Model for a domestic corporation and a MNC. Discuss each part of the formula and how changes in exchange rates effect values.

Answer 1

Valuation of a domestic company can be done by using the following formula

= FCF1 / ( WACC- g)

The free cash flows for next year is used. Free cash flows exclude the capital expenditure. WACC represents the cost of capital of the company while g= growth rate. Thus the Free cash flows are discounted by the difference between WACCand growth rate to arrive at the value of the company.

Valuation of an MNC can be done using the formula

Sum of (CFn/ (1+k)^n)

wherin CFn represents cash flows every nth year

This is discounted by the weighted average cost of capital (k)

Changes in exchange rates have an impact on the cash flows of an MNC. The Cash flows mentioned in the formula above are the product of cash flows in foreign currency and exchange rate at which the foreign currency can be converted into the home curency. Thus an increase in the value of home currency will result in higher cash flowsand vice versa. It can hence be concluded that higher the value of the home currency, higher will be the value of the MNC and lower the value of home currency in comparison to the foreign currency, lower will be the value of MNC even though the cashflows as suchhave not changed.