508  Cross-Border Valuation
one of the two following methods for forecasting and discounting cash flows 
denominated in foreign currency.
1. Spot-rate method. Project foreign cash flows in the foreign currency, and dis-
count them at the foreign cost of capital. Then convert the present value of 
the cash flows into domestic currency, using the spot exchange rate.
2. Forward-rate method. Project foreign cash flows in the foreign currency, 
and convert these into the domestic currency, using the relevant forward 
exchange rates. Then discount the converted cash flows at the cost of 
capital in domestic currency.
Let’s use a simple example to illustrate. Assume you want to estimate the 
value of a Swiss subsidiary for its German parent company as of January 2020. 
Exhibit 27.1 shows the cash flow projections for the subsidiary in the foreign 
currency (Swiss francs).
EXHIBIT 27.1  Cash Flows Projected and Discounted under Consistent Monetary 
Assumptions
Consistent 
assumptions on 
inflation, interest, and 
currency rates
Foreign currency, 
Swiss francs (CHF)
2021
2022
2023
2024
2025
2026
Cash flows, CHF million
Nominal cash flow
103.0
106.6
110.9
115.4
120.1
124.9
Real cash flow
102.5
105.1
107.7
110.4
113.1
116.0
Inflation, %
0.50
1.00
1.50
1.50
1.50
1.50
Interest rates, %
Real interest rate
3.00
3.00
3.00
3.00
3.00
3.00
Nominal forward interest rate
3.52
4.03
4.55
4.55
4.55
4.55
Nominal interest rate
3.52
3.77
4.03
4.16
4.24
4.29
Foreign-exchange rates, 
CHF/Euros (€)
Spot exchange rate
1.200
Forward exchange rate
1.194
1.188
1.177
1.165
1.154
1.137
Domestic currency, €
Interest rates, %
Nominal interest rate
4.03
4.29
4.71
4.93
5.06
5.23
Nominal forward interest rate
4.03
4.55
5.58
5.58
5.58
6.09
Real interest rate
3.00
3.00
3.00
3.00
3.00
3.00
Inflation, %
1.00
1.50
2.50
2.50
2.50
3.00
Cash flows, € million
Real cash flow
85.4
87.6
89.7
92.0
94.3
96.6
Nominal cash flow
86.3
89.8
94.3
99.1
104.1
109.9

Forecasting Cash Flows  509
To value the subsidiary using the spot-rate method, simply discount nomi-
nal cash flows in Swiss francs (CHF) at the Swiss nominal risk-free interest 
rates (we assume the subsidiary’s beta is zero). The resulting present value 
is 589.9 Swiss francs. Converting this value at the spot exchange rate of 1.200 
Swiss francs per euro results in a discounted-cash-flow (DCF) value of €491.6 
million:
Year
2021
2022
2023
2024
2025
2026
Spot-rate method
Cash flow, CHF million
103.0
106.6
110.9
115.4
120.1
124.9
Discount factor
0.966
0.929
0.888
0.85
0.813
0.777
Present value of cash 
flow, CHF million
99.5
99.0
98.6
98.1
97.6
97.1
DCF value, CHF 
million
589.9
DCF value, € million
491.6
Note: Numbers may not sum due to rounding.
The forward-rate method for valuation is more elaborate. The projected 
nominal cash flows in Swiss francs are now converted to euros on a year-
by-year basis, using forward exchange rates and then discounted at nominal 
euro interest rates. Estimate synthetic forward rates by using interest par-
ity as described in the forward exchange rate section below. You could use 
market-based forward exchange rates, too, but check for interest-rate parity 
to ensure consistent valuation results across currencies. We obtain a present 
value of €491.6 million, exactly the same value as obtained under the spot-rate 
method:
Year
2021
2022
2023
2024
2025
2026
Forward-rate method
Cash flow at forward 
exchange rate, € million
86.3
89.8
94.3
99.1
104.1
109.9
Discount factor
0.961
0.919
0.871
0.825
0.781
0.737
Present value of cash flow, 
€ million
82.9
82.5
82.1
81.7
81.3
80.9
DCF value, € million
491.6
Note: Numbers may not sum due to rounding.

510  Cross-Border Valuation
The results for the spot-rate and forward-rate valuations are identical be-
cause the domestic and foreign cash flows are projected and discounted under 
consistent monetary assumptions, as shown in Exhibit 27.1. As we explain 
in more detail in the two following sections, you cannot make independent 
assumptions for inflation, interest rates, and forward exchange rates across 
currencies:
• Inflation assumptions underlying cash flow projections in a specific cur-
rency must be consistent with inflation assumptions underlying interest 
rates in that currency.
• Forward exchange rates between two currencies must be consistent 
with inflation and interest rate differences between those currencies.
• Conversion of cash flow projections from one currency into another 
should be done at forward exchange rates.
Inflation and Interest Rates
Inflation and interest rates should be projected in accordance with the 
Fisher effect.1 For each currency, the inflation rate it in each year should 
align with the nominal forward interest rate (ft) and real interest rate (Rt) 
in that year:
1
1
1
+
(
) =
+
(
)×
+
(
)
f
R
i
t
t
t
For example, in Exhibit 27.1, the Swiss forward interest rate in 2022 equals the 
real interest rate plus the expected inflation rate for that year:
4 03
1
3 00
1
1 00
1
.
%
.
%
.
%
=
+
(
)
+
(
) −
The two-year interest rate as of 2020 is the geometric average of the first- and 
second-year nominal forward interest rates:
3 77
1
3 52
1
4 03
1
1 2
.
%
.
%
.
%
=
+
(
)
+
(
)
[
]
−
/
Forward Exchange Rates
Forward exchange rates should reflect inflation and interest rates following 
interest rate parity. For currencies with liquid forward markets, arbitrage 
1 See, for example, R. Brealey, S. Myers, and F. Allen, Principles of Corporate Finance, 13th ed. (Burr 
Ridge, IL: McGraw-Hill/Irwin, 2020), chap. 27.