Foreign Exchange Market Analysis - Essay Example

Foreign Exchange Market Analysis of supervisor al affiliation Introduction Peterson Valve Company should perform suitable procedures to ensure that they have link to Milagrol LTDA information and all the risks they are being exposed to. The information should be collected and analyzed by an expert to ensure that Peterson Valve Company makes the right decision on buying the company. Valuation of the Milagrol LTDA should be done with due diligence by experts in valuation to avoid mistakes of under or over valuation. Political risks associated with inter transfer of business should be carefully evaluated to ensure that the buyer is not affected by the political decisions or to avoid valuation problems. My paper discusses some political risks, the implications, methods of valuation of stock, and risks associated with buying a business. Peterson Valve Company is interested in Milagrol LTDA because he thought of diversifying its operations globally and to gain access to processes that would be costly to develop. Milagrol LTDA needed the capital to support research and development to expand the business and they believed in venturing into a merger to be able to manage the research to expand the business. Milagrol was an already established company and had its share value in the market so Peterson did not have to start from scratch to develop the company. In buying a business an investor has to ensure that they have access to all important information about the company being bought, this way they can assess the potential risks associated with buying it and the real value of the business (Juha, 2008). Accessing all information of the company involves checking all the dimensions of the business such as financial performance, legal and tax compliance, contracts, property and rights and all assets and liabilities within a specified period of time (Miller, 1992). Some of the risks involved include changes in the branding of the company. These information will be crucial in making the buying decision and also help the values in reaching to a final method of stock valuation. The customers of Milagrol LTDA may have problems with a change in the management. Smart accountants can hide items such as debts of the company from the balance sheet and some of the expenses from the income statement hence acquiring a business with accumulated debts. Consider the possibility of transferring losses from the old company to the newly acquired business, the practice of moving the business assets allows the newly acquired management to differentiate assets that they can develop from long term and short term losses. Mismanagement of the Milagrol LTDA may affect the Peterson valve company development especially from acquisition of mergers and contracts. It may also influence the decisions of other bigger companies that would want to work with the newly acquired Peterson Valve Company which will not be in a positive way. The Milagrol LTDA may have dishonored contracts hence becoming a disadvantage to the enter valve in case they would want to venture into business with another company. The financial statements of the company may be under or overstated to hide or reveal items that are not there in actual sense. Consider the risks that may be associated with the foreign exchange rates used by the Milagrol LTDA throughout the year as this has an effect on the valuation of the company and the comparison between the rates of the US dollars and the Brazilian reais. Over and undervaluation when buying Milagrol LTDA is another major risk, Peterson valve company should seek the help of experts in valuation. Inventory at the time of the selloff may be obsolete or may have no worth. Employees may fail to perform as good under the new management and the environment could become unfriendly to the new organization. The company might not have complied to legal and tax requirements effectively hence posing a tax and legal threat to Peterson valve company of maybe having to pay hefty fines (Hallikas, et al., 2002). It is hard to understand how stock analysts come up with prices for businesses on sale that vary so much or how they agree to a fair value for companies. Discounted cash flow is a method used to value the intrinsic value of a company or the assets. Discounted cash Flow (DCF) projects the Net present Value that could be made available to investors’ interested shareholders in the future (Pastor & Pietro, 2003). It is commonly referred to as a method that considers the present money in the company more than the future, as it lays more emphasis on the net value. DCF relies on the image of the organization or company to the public sector and the potential investors or past historical events and is based on assumptions such as foreign exchange rates, current currency valuation and political decisions. DCF makes use of financial ratios and multiples to assure the investors of a solid value of stock in comparison to other competitors in the market (Wendt, 1965). There are different types of DCF models being the free cash flow to equity and cash flow to the firm that are actively used by stock analysts. Cash flow to equity involves cash flows available on the management and cash flow to the firm involves the cash flows available to bond and shareholders of the company that has proved to be more complex to understand in time. The main components of the DCF model include the discount rate, terminal value of stock and the cash flow available to all capital providers. The DCF analysis has several steps in order to reach to a fair value for the business (Bakshi & Chen, 2005). First the analyst Peterson Valve used need to estimate the future cash flows of Milagrol LTDA. This stage is complex as it involves estimating variables such as growth of future sale or the profits margin of the company. Secondly asses the trends in the growth of the industry Milagrol LTDA is involved in, the competitive advantage over other similar companies in the market and the economic data of the company to predict the growth of Milagrol LTDA. According to the information given Milagrol gives a bright growth rate in future as it has acquired its quality share in the market. From the cash flow choose an appropriate discount rate that is then used to calculate the net present value. Factors to consider carefully when analyzing the stock involve variables such as the rates of inflation and discount rates (Sterling, 1971). The expected price for Milagrol LTDA from the cash flow is expected to be the free cash flow + net working capital + Net Property, plant and equipment which in valued in thousands of BRL. 67124+ 62254+184456 = 313834 thousand BRL. How to use DCF DCF makes use of financial ratios and multiples to assure the investors of a solid value of stock in comparison to other competitors in the market (Wendt, 1965). The DCF analysis has several steps in order to reach to a fair value for the business (Bakshi & Chen, 2005). First the analyst need to estimate the future cash flows of a company. Secondly asses the trends in the growth of the industry the company is involved in, the competitive advantage over other similar companies in the market and the economic data of the company to predict the growth. From the cash flow choose an appropriate discount rate that is then used to calculate the net present value. Political risk is the chances of losses in a business due to decisions made by the political sector, these risks are also known as geopolitical risks (Kobrin, 1979). Decisions made by political leaders about a business can affect the valuation or the profitability of a business. In this case political decisions made by the government can affect the valuation of Milagrol LTDA. Such decisions include, currency valuation, tax decisions, and levels of wages, environmental and developmental policies, trade barriers, and investment decisions. These political risks are included in the estimates and the expose of chances of risks occurring that are included in a company’s prospectus (Fitzpatrick, 1983). Currency valuation depends on the current market trends in the country and this affects the valuation of stock, the BRL and the USD should be valued well to avoid over estimation or under estimation, the variations should not be so wide. The environmental and developmental policies are affected by current situations and they are also influenced by political situations such as terrorism, wars, political elections, possible coups and international wars. Political risk does not dictate the political situation of a country as this is just based on decisions (Kobrin, 1979). Conclusion Despite having different methods of valuing stock, these methods are dependent on the type of business being valued, the type of goods and services delivered and the purpose for valuation (Wendt, 1965). The discounted cash flow method is the best asset valuation method for the analysts that Peterson Valve uses to value Milagrol, this is because the cash flows for Milagrol LTDA are provided and the estimates are clearly stated. This method basically uses financial ratios whose variables are difficult to estimate so simple errors may cause over or under valuation. The risks associated with acquiring a business that is already existence can be avoided by seeking expert legal, financial, and social advice to avoid venturing into businesses’ that will only incur losses. Bibliography Bakshi, G. & Chen, Z., 2005. Stock Valuation in Dynamic Economies. Journal of Financial Markets, 8(2), pp. 111-151. Fitzpatrick, M., 1983. The efinition and Assesment of Political Risk in International Business: A Review of Literature. Academy of Management Review, 8(2), pp. 249-254. Hallikas, J., Virolainen, V. M. & Tuominen, M., 2002. Risk Analysis and Assesment in Network Environments. Journal of Production Economics, 78(1), pp. 45-55. Juha, M. P., 2008. Managing Risks in Organizational Purchasing Through Adaptation of Buying Center Structure and the Buying Process. Journal of Purchasing and Supplies Management, 14(4), pp. 253-262. Kobrin, S. J., 1979. Political Risk: A Review and Reconsideration. Journal of International Business Studies, pp. 67-80. Miller, K. D., 1992. A Framework for Integrated Risk Management in International Business. Journal of International Business Studies, pp. 311-331. Pastor, L. & Pietro, V., 2003. Stock Valuation and Learning about Profitability. Journal of Finance, 58(5), pp. 1749-1790. Sterling, R. R., 1971. Asset Valuation and Income Determination: a Consideration of the Alternatives. 2nd ed. s.l.:scholars book Co. tseng, c.-L. & barz, g., 2002. short-term generation asset valuation: a real option approach.. operations research, 50(2), pp. 297-310. Wendt, P. F., 1965. Current Growth Stock Valuation Methods: General Motors- An Illustration. Financial Analysts Journal, 21(2), pp. 91-103. Read More