EECS 1520 Lecture 3: EECS 1520 Lecture 3 Notes
21 Jun 2018
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EECS 1520 Lecture 3 Notes
Introduction
How Uncertainty Affects the MNC’s Cost of Capital
The expected dollar cash flows from U.S. operations are reduced.
The expected euro cash flows are reduced and the expected exchange rate is lower
Both of these factors reduce the estimate of dollar cash flows from foreign operations.
The expected annual dollar cash flows for Austin in the original example were $66
million, whereas the revised expectation is only $57.2 million.
This example clearly illustrates just how adversely an MNC’s cash flows can be affected
by exposure to international conditions.
If there is suddenly more uncertainty about an MNC’s future cash flows, then investors
will expect to receive a higher rate of return.
Thus more uncertainty increases the return on investment required by investors (and
thus the MNC’s cost of obtaining capital), which lowers the firm’s valuation.
EXAMPLE
Since Austin Co. does substantial business in Europe, its value is strongly influenced by
how much revenue it expects to earn from that business.
As a result of some events that occurred in Europe today, economic conditions in
Europe are subject to considerable uncertainty.
Although Austin does not change its forecasts of expected cash flows, it is concerned
that the actual flows could deviate substantially from those forecasts.
The increased uncertainty surrounding these cash flows has increased the firm’s cost of
capital, because its investors now require a higher rate of return.
In other words, the numerator (estimated cash flows) of the valuation equation has not
changed but the denominator has increased owing to the increased uncertainty
surrounding the cash flows.
Thus, the valuation of Austin Co. has decreased.
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Document Summary
How uncertainty affects the mnc"s cost of capital. The expected dollar cash flows from u. s. operations are reduced. The expected euro cash flows are reduced and the expected exchange rate is lower. In other words, the numerator (estimated cash flows) of the valuation equation has not changed but the denominator has increased owing to the increased uncertainty surrounding the cash flows. Thus, the valuation of austin co. has decreased. In some periods, the uncertainty surrounding conditions that influence cash flows of. Expected euro cash flows are reduced and the expected exchange rate is lower. Both of these factors reduce the estimate of dollar cash flows from foreign operations. The expected annual dollar cash flows for austin in the original example were million, whereas the revised expectation is only . 2 million. This example clearly illustrates just how adversely an mnc"s cash flows can be affected by exposure to international conditions.
