If exchange rate depreciate, what will happen to the parent company NPV of foreign cashflow?
When an exchange rate depreciates, it means that the value of one currency decreases relative to another currency. In the context of foreign cash flows and the parent company's Net Present Value (NPV), the impact of a depreciating exchange rate can be analyzed as follows:
1. Evaluate the foreign cash flows: Begin by calculating the cash flows of the foreign subsidiary in its local currency. This can include revenues, expenses, taxes, and other financial factors. Determine these cash flows in the subsidiary's functional currency.
2. Convert cash flows to parent company's currency: Once the cash flows are determined in the subsidiary's functional currency, they need to be converted into the parent company's currency. This conversion is necessary to evaluate the impact on the parent company's financials.
3. Consider the exchange rate: The exchange rate comes into play when converting the subsidiary's cash flows into the parent company's currency. If the exchange rate has depreciated, it means that the parent company will receive fewer units of the subsidiary's currency when converting it. This effectively reduces the value of the foreign cash flows in the parent company's currency.
4. Calculate the NPV: After converting the foreign cash flows into the parent company's currency, you can calculate the Net Present Value (NPV) using the appropriate discount rate. The NPV represents the present value of these cash flows taking into account the time value of money.
Therefore, if the exchange rate depreciates, it can potentially lower the NPV of the parent company's foreign cash flows. This is because the weaker exchange rate reduces the value of the foreign cash flows when converted into the parent company's currency. However, it is important to note that exchange rates can fluctuate, and their impact on NPV can vary based on several factors, such as the size of the subsidiary's cash flows and the sensitivity of the parent company's financials.