Question

Which currency between the home currency approach or foreign currency approach is better for US firms and Singapore firms? why?

Answer 1

US and Singapore firms - Home currency approach.

While evaluating a foreign investment proposal, the company neet to decide upon the mehtod they need to evaluate the foreign project. The most popular and widely used methods are home currency approach and foreugn currency approach. The former involves converting the foreign project cash flows to local currency based on expected forward exchange rates and discounting them based on home country cost of capital. The later requires calculating NPV based on foreign country cost of capital and then converting the foreign-currency NPV to local currency at the spot exchange rate.

Since these approaches involve foreign currencies, the evaluation of the same involves flactuation risks of foreign currencies. Foreign projects must be evaluated from the perspective of the parent company. A project might make sense in the foreign country when executed by a company based in that country but might not be feasible after considering the foreign exchange risk, taxation and restriction of repatriation of income back to the home country.

As we know, the exchange rate of US and Singapore dollars are higher compared with that of the other countries. Since the exchange rates are higher for their home currencies, and they amount of investments they make are valued at their home currency and are compared with such similar firms. As the home of these countries are more powerful and consistent than all other currencies, these countries prefer to follow home currency approach.