Question

In accordance with the valuation formula of a U.S. based multinational corporation, $PastedImage_7zpaz15q4fbuawza8w0212h272q9$ ,

which of the following is correct for JJ Company (a U.S. based multinational corporation)? JJ Company has a subsidiary established in China.

Question options:

	If the economic condition in China weakens, the value of JJ company increases.
	If the required rate of return by investors, k, increases, the value of JJ company increases.
	If the U.S. dollar appreciates against Chinese Yuan (i.e., Chinese Yuan appreciates against the U.S. dollar), the value of JJ company decreases.
	If China increases corporate taxes on subsidiaries of the U.S. based multinational corporations, the value of JJ company increases.

Answer 1

The correct answer is C or the third option: "If the US dollar appreciates against Chinese Yuan, the value of the JJ company decreases.  

Reason : Since the subsidiary is based in China, it can be assumed that it generates cashflows in Chinese Yuan. However, since the US dollar appreciates in this scenario, this will result in a lower value when consolidated into financials (meaning, lesser dollar amount is received by the US holding company for each unit of Yuan earned). Hence, this would cause a decrease in the value of JJ company.

The first statement is incorrect - As deterioration in Chinese economy means lower earnings for the Chinese subsidiary. Thus, resulting in a decrease in value of JJ company.

The second statement is incorrect because if required return by investors (k) increases, the discounting factor (or the denominator in the formula) also increases which would cause fall in the value of JJ's shares. In other words, the hurdle rate is increasing which is detrimental to the company.

The fourth statement is also incorrect, as an increase in corporate taxes will result in lower net earnings of the Chinese subsidiary. As a result the cashflows or earnings from the holding company's perspective (also financial consolidation) is lower, resulting in a decreased valuation.