Valuing Cash Flows in More Than One Currency

An analyst modeling a Mexican subsidiary of a US company has cash flows that naturally arrive in pesos, but the parent company reports in dollars and its investors think in dollar returns. Discount the peso cash flows with a dollar cost of capital, or convert everything to dollars first and use a peso rate, and the valuation is silently wrong — often by a lot, because the two currencies have very different inflation and interest-rate environments baked in.

Two consistent routes, not one shortcut

There are exactly two correct ways to value cross-currency cash flows, and they must give the same answer if built consistently.

Route 1 — value in local currency. Forecast the cash flows in pesos, discount them with a peso-denominated cost of capital (which will run higher than the dollar rate if peso inflation and risk are higher), get a value in pesos, then convert that single final number to dollars at today's spot rate.

Route 2 — value in parent currency. Convert each year's peso cash flow to dollars using a forecast FX rate for that year (not today's spot rate), then discount the resulting dollar cash flows with a dollar cost of capital.

The forecast FX rates used in Route 2 are not guesses — they come from the same interest-rate parity relationship that prices FX forwards: a currency with higher expected inflation is expected to depreciate against one with lower inflation, roughly at the rate of the inflation differential. This is why the two routes agree: Route 1's higher peso discount rate and Route 2's assumed peso depreciation are two ways of expressing the same economic fact.

Route 2: parent currency convert cash flows every year discount at USD rate

same answer, if the FX forecast and the rate gap are consistent

Worked example

A Mexican operating unit generates a real (inflation-adjusted) peso cash flow next year of MXN 200 million. Peso inflation is forecast at 6%, dollar inflation at 2%, so nominal peso cash flow next year is $200\text{m} \times 1.06 = 212$ million pesos. Spot is MXN 18.00 per USD.

1. Route 1. Peso cost of capital is 13% (roughly the 9% dollar cost of capital plus the ~4-point inflation gap). Discounting: $212 / 1.13 = 187.6$ million pesos in present value. Convert at spot: 187.6\text{m} / 18.00 \approx \10.42$ million.
2. Route 2. The forward FX rate for one year out, from interest-rate parity, is roughly $18.00 \times 1.06/1.02 \approx 18.71$ pesos per dollar. Convert the nominal cash flow: 212\text{m} / 18.71 \approx \11.33$million. Discount at the 9$11.33 / 1.09 \approx $10.39$ million.

Both routes land close to $10.4 million; the small gap is rounding in the approximate parity formula, not a modeling error.

What this means in practice

The single most common mistake is using today's spot rate to convert every future year's cash flow — that quietly discards the inflation differential and biases the value upward for any currency expected to depreciate. Analysts also frequently forget to check that the risk-free rate embedded in each currency's cost of capital is genuinely that currency's own rate (a peso-denominated risk-free rate, not a dollar one with a spread bolted on), since mixing risk-free rates across currencies reintroduces the same inconsistency in a subtler form.