If an MNE conducts a project analysis of a foreign project whose cash flows are in a foreign currency, then the issue of the additional risk caused by fluctuating exchange rates arises. Companies in practice handle this issue in several different ways. Which of the following procedures is/are recommended in the text?
A) Estimate the project's cash flows in the foreign currency and discount them at the appropriate host country discount rate. Convert the resulting foreign currency NPV into equivalent dollars using the current spot rate.
B) Estimate what the project's cash flows would be if they were generated in the home currency and discount them at the appropriate home country discount rate. The NPV will already be in the home currency.
C) Estimate the project's cash flows in the foreign currency and then use forward rates, interest rate parity, purchasing power parity, or other such theory to convert them into expected home currency cash flows. Discount them at the appropriate home country discount rate, and the NPV will already be in the home currency.
D) Both statements a and c are recommended.
E) Both statements a and b are recommended.

Question

Quizplus · Accepted Answer

Both estimating the project's cash flows in the foreign currency and discounting them at the host country discount rate before converting to the home currency (A), and estimating cash flows in the foreign currency then converting them into expected home currency cash flows using financial theories before discounting at the home country rate (C), are recommended practices for handling exchange rate risk in international project analysis.

If an MNE Conducts a Project Analysis of a Foreign