Using Translated Foreign-Currency Financial Statements  523 consistent with 14 percent inflation in the foreign country during the year and U.S. inflation of 2 percent. The average exchange rate for the year is 0.90. As the exhibit illustrates, the three approaches can result in significantly different amounts for net income and equity in the parent company’s currency. Of course, these differences should not affect your estimate of free cash flow for the subsidiary. As a general rule, you should ensure that translation adjustments in components of invested capital are excluded from the invest- ment cash flows. Under IFRS, companies typically specify currency translation adjustments by category of fixed assets, so that you can identify the “cash” investments. Under U.S. GAAP, this information is usually not provided; you will have to add back the translation results to the change in invested capi- tal. For the analysis of historical performance, ratios such as ROIC, operating margin, and capital turnover typically are not significantly distorted under the current method. You do have to adjust growth rates for currency translation effects (see also Chapter 12). For translated financial statements from hyper- inflation countries, we recommend you analyze performance based on the original statements or by reversing translations made for the key operating items (following the analysis recommendations found in Chapter 35). EXHIBIT 27.6  Currency Translation Current method Temporal method Inflation-adjusted currency method Local currency Foreign- exchange rate U.S. $ Foreign- exchange rate U.S. $ Adjusted Foreign- exchange rate U.S. $ Balance sheet Cash and receivables 100 0.85 85 0.85 85 100 0.85 85 Inventory 300 0.85 255 0.90 270 321 0.85 273 Net fixed assets 600 0.85 510 0.95 570 684 0.85 581 1,000 – 850 – 925 1,105 – 939 Current liabilities 265 0.85 225 0.85 225 265 0.85 225 Long-term debt 600 0.85 510 0.85 510 684 0.85 581 Equity Common stock 100 0.95 95 0.95 95 100 0.95 95 Retained earnings 35 – 32 – 95 56 – 48 Foreign-currency adjustment – – (12) – – – – (10) 1,000 – 850 – 925 1,105 – 939 Income statement Revenue 150 0.90 135 0.90 135 161 0.85 137 Cost of goods sold (70) 0.90 (63) 0.93 (65) (75) 0.85 (64) Depreciation (20) 0.90 (18) 0.95 (19) (23) 0.85 (20) Other expenses, net (10) 0.90 (9) 0.90 (9) (11) 0.85 (9) Foreign-exchange gain/(loss) – – – – 66 201 0.85 17 Income before taxes 50 – 45 – 108 72 – 61 Income taxes (15) 0.90 (13) 0.90 (13) (16) 0.85 (13) Net income 35 – 32 – 95 56 – 48 1 Gain from restatement. 524  Cross-Border Valuation Summary In principle, applying the DCF valuation approach to foreign businesses is the same as applying it to domestic companies. But there are some additional issues to consider. You’ll want to reflect local accounting in your analysis, fol- lowing the general guidelines from Chapter 11. Because IFRS and U.S. GAAP are now the dominant standards, accounting issues have become less of a burden. You can project and discount cash flows for foreign businesses in foreign or domestic currency if you apply consistent assumptions for exchange rates, interest, and inflation and if you correctly apply the spot-rate or forward-rate method of valuation. The approach for estimating the cost of capital should be the same for any company anywhere in the world. With the global integration of capital markets in mind, we recommend using a single real-terms, risk-free rate and market risk premium for companies around the world. For inves- tors and companies facing restrictions on investing abroad, we recommend estimating a local cost of capital. It is not necessary to add separate premiums to the cost of capital to address currency risks. These are best reflected in a scenario-based valuation. Part Four Managing for Value 527 28 Corporate Portfolio Strategy A company’s value depends greatly, though not entirely, on the actions of its managers. In 2018, colleagues of ours published the results of their global research on 2,393 companies, in which they identified the core drivers that helped some ascend to the top quintile of value creators.1 These drivers of value included the industry and geography in which the company partici- pated plus five strategic management actions: changing the business portfolio (through programmatic acquisitions and divestitures), allocating resources, spending capital, improving productivity, and innovating to differentiate products and services better. Applying a management perspective to the science and art of value cre- ation is the focus of the seven chapters that make up Part Four of this book. Specifically, we examine two critical top management decisions: What should executives decide to hold in the company’s portfolio of businesses? And how should they allocate resources in support of decisions on capital expenditures, research and development (R&D), talent management, and more? We also ex- plore managing the performance of the company’s businesses through target setting, monitoring performance, and taking corrective action where neces- sary. We begin in this chapter with the question of what businesses a company should be in, along with two related questions: What constitutes being the best owner of a company, and how might the best owner change over time? The chapter also discusses how a business portfolio evolves and how to manage 1 C. Bradley, M. Hirt, and S. Smit, Strategy Beyond the Hockey Stick (Hoboken, NJ: John Wiley & Sons, 2018).