Modelling the dynamics of firm valuation: An assessment of impact of exchange rate fluctuations on firm value using system dynamics

Abstract

Exchange rate volatility is a vital issue in international finance due to its effect on the value of the firm, depending on firm's exposure to the exchange rate risk. However, this impact is not clear in literature as evidence is mixed. This article analyses the impact of exchange rate fluctuations on firm value. A system dynamics-based corporate planning model has been developed that incorporates the modules for financial and physical processes, firm valuation and exchange rate determination. Simulation results reveal that a stronger home currency leads to an increase in market price per share of the firm and vice versa. The results provide counter intuitive evidence on the impact of exchange rate on firm value and provide nonlinear feedback loop-based explanation. The study fills the gap in literature by incorporating a systemic approach in the strategic planning process to assess the composite impact of parameter changes on key variables.