Should MNCs Use Forward Rates to Estimate Dollar Cash Flows of Foreign Projects?
POINT: Yes. An MNC's parent should use the forward rate for each year in which it will receive net cash flows in a foreign currency. The forward rate is market-determined and serves as a useful forecast for future years.
COUNTER-POINT: No. An MNC should use its own forecasts for each year in which it will receive net cash flows in a foreign currency. If the forward rates for future time periods are higher than the MNC's expected spot rates, the MNC may accept a project that it should not accept.
WHO IS CORRECT? Which argument do you support?
The key on answering this question hinges upon the issue of forecasting. How good can MNCs forecast about future exchange rates relevant to their cash flows. The ...
MNCs are normally used forward rates to forecast for their future cash flows of foreign projects. Forward rates are fairly good forecast for future spot rates relevant to their cash flows. This is a conservative approach unless MNCs have better forecasts to be used.