International investment appraisal
and, all things being equal, so will be future profits that those assets might generate.
The evidence seems to show that, in such circumstances, the business’s stock market
value will fall. Given that the objective of most businesses seems to be to enhance
shareholders’ wealth, it seems difficult to deny that translation risk is a real issue.
On the other hand, it can be argued that the assets in the foreign country are equally
productive and valuable as measured by the local currency, irrespective of that cur-
rency’s value relative to other currencies.
The question probably hinges on the location and local currency of the shareholders.
If they are in the business’s home country, the value of their assets in terms of the home
currency will be less. If they are elsewhere this may not be a problem.
Managing translation risk
Translation risk is very difficult to manage and, as with economic risk, it tends to be
more at the strategic level that managing it can best be attempted. The following might
be possible:
l avoiding being too exposed to one single foreign currency by having operations in
a range of countries each with different, unlinked, currencies;
l trying to trade in foreign countries where there is known to be some intent on the
government’s part to hold the home currency at a broadly constant exchange rate
with the relevant foreign currencies; and
l taking steps to try to finance much of the foreign investment with funds borrowed
in the local currency, so that translation losses of assets’ values are matched by
gains on liabilities.
As with transaction risk and, to a lesser extent, economic risk, there are arguments
for ignoring translation risk. One reason is the commercial inconvenience and cost of
taking the strategic steps listed above. For example, it may be very expensive to raise
finance in a country where the business wishes to make an investment in a manufac-
turing plant. The other reason, which is concerned with portfolio effects, we shall con-
sider later in the chapter, in section 15.5. Many UK businesses seem not to hedge
translation risk.
The food manufacturer Associated British Foods plcpartially hedges its transla-
tion risk. In its 2007 annual report, the business said:
The group publishes its financial statements in sterling and conducts business in many
foreign currencies. As a result, it is exposed to movements in foreign currency exchange
rates which affect the group’s transaction costs and the translation of the results and
underlying net assets of its foreign operations into sterling. The group does not hedge
the translation impact of exchange rate movements on the income statement. A partial
hedge of the balance sheet translation exposure is provided by borrowing in the cur-
rencies of some of the group’s overseas assets, as well as the designation of certain inter-
company borrowings as a further partial hedge.
15.4 International investment appraisal
In essence, all investments should be appraised in exactly the same manner. This is
irrespective of whether cash flows from them will emanate, partly or fully, from a for-
eign country or exclusively from the home country. NPV is applicable to all invest-
ments, wherever they may be located, and in whichever currency the cash flows are
