Question

Foreign Exchange Risk and Capital Budgeting.

How is foreign exchange risk sensitivity factored into the capital budgeting analysis of a foreign? project?

Please answer this question IN YOUR OWN WORDS.

Answer 1

We are try to understand the sensitivity of foreigin exchange risk factored through this way the project team assumed that the Indian rupiah would depreciate Against the U.S. dollar at the purchasing power parity “rate” (approximately 10.767% every year in the basic analysis).
What happend if the rate of depreciation of rupiah were greater? Now this event would make the assumed cash
flows to Cemex worth less in dollars, operating exposure analysis would be necessary to determine whether
the cheaper rupiah made Semen Indonesia more competitive.For example, since Semen Indonesia’s exports to Taiwan are denominated in U.S. dollars, a weakening of the rupiah versus the dollar could result in greater rupiah earnings from those export sales. This serves to somewhat offset the imported components that Semen Indonesia purchases from the parent company that are also denominated in U.S. dollars. Semen Indonesia is representative of firms today that have both cash inflows and outflows denominated in foreign currencies, providing a partial natural hedge against currency movements.
What if the rupiah should appreciate against the dollar? The same kind of economic exposure analysis is
needed. In this particular case, we can guess that the effect would be positive on both local sales in
Indonesia and the value in dollars of dividends and license fees paid to Cemex by Semen Indonesia. Note,
however, that an appreciation of the rupiah might lead to more competition within Indonesia from firms in
other countries with now-lower-cost structures, lessening Semen Indonesia’s sales.