702  Emerging Markets
Every forecast of a company’s financial performance is based on assump-
tions about real GDP growth, inflation rates, interest and exchange rates, and 
whatever other parameters, such as energy prices, are relevant. In emerging 
markets, these parameters can fluctuate wildly from year to year. It becomes 
all the more important that forecasts be based on an integrated set of economic 
and monetary assumptions of future inflation, interest rates, exchange rates, 
and cost of capital (see Chapters 26 and 27 for more details). For instance, 
make sure that the same inflation rates underlie the financial projections and 
cost of capital estimates for the company.
One parameter deserves special attention: exchange rates. Although ex-
change rates converge to purchasing power parity (PPP) in the long run,9 
short-term deviations can be sizable and last for several years—especially in 
the case of emerging markets. In Chapter 27, Exhibit 27.3 shows how even 
on an inflation-adjusted basis, the exchange rate of Brazil’s currency, the real 
(plural: reais), has fluctuated strongly over the past 50 years versus the U.S. 
dollar. If the long-term average real exchange rate is indicative of PPP,10 the 
Brazilian currency could have been overvalued versus the U.S. dollar and 
other currencies by as much as 20 to 35 percent in 2008. Any exchange rate 
convergence to PPP would not be likely to affect the cash flows and value 
generated by a retailer, as its revenues and costs are mainly determined in 
Brazilian reais. But an exchange rate change would affect its cash flow and value 
measured in foreign currency. Because predicting exchange rates is virtually 
impossible,11 a range estimate of the impact on a company’s value measured 
in foreign currency is more meaningful. For primarily local companies, like 
retailers, it would therefore be best to perform the DCF valuation in Brazil-
ian reais and—if needed—translate the result at both the actual and the PPP 
exchange rates to obtain a value range in foreign currency.
Fortunately, many of the complications arising from different account-
ing standards have been resolved over the past decades. Almost all countries 
outside the United States have adopted IFRS accounting standards, with the 
notable exceptions of China and India. This has reduced the complexity of 
adjusting their financial statements for valuation purposes. Even in China and 
India, the vast majority of accounting standards have been converging with 
IFRS and are now substantially the same.
Nonoperating assets remain a challenge, however. Companies in emerging 
markets—which are often conglomerates with a wide range of businesses—
frequently have a large amount of nonoperating assets, including unconsoli-
dated equity investments and real estate. For example, Reliance Industries, 
9 For an overview, see A. M. Taylor and M. P. Taylor, “The Purchasing Power Parity Debate,” Journal of 
Economic Perspectives 18, no. 4 (Fall 2004): 135–158.
10 See Chapter 27 for more details on PPP and exchange rates.
11 As Exhibit 27.3 also shows, the Brazilian real further strengthened against the U.S. dollar and other 
currencies in real terms after 2008, before showing some correction in 2013.