Functional currency and firm value in Mexico

Abstract

In this paper, we analyze the effect of adopting a functional currency on tax collection and the value of the firm in Mexico. Our hypothesis is that, beyond the administrative benefits, it would reduce the exchange risk, and therefore increase the value of the companies. Using data from S&P Capital IQ we found that, at a rate of 30%, income tax collection increases slightly. By approximating the value of the firm with the present value of after-tax financial flows minus the payment of a risk premium, we find that functional currency tends to increase the value of the firm. With the utility theory method, the improvement can go from 19 to 30 percentage points of the value of the firm. This improvement in profitability is equivalent to a reduction of between 0.3 to 2 percentage points in the interest rate of operating in Mexico.