Question

You are considering a project in South Korea. The cash flows are in South Korean won (KRW). Given your current estimates of the future spot rate of USD/KRW, the NPV is positive. Explain why you should proceed with the project. If you think the South Korean won will appreciate more against the dollar than what you originally estimated will this make it more or less likely that you proceed with the project. Explain.

Answer 1

Since the NPV is positive we have to accept the project, But we are uncertain as going forward our NPV many change due to exchange rate fluctuation.

So let us see how to evaluate the project.

We are in US and we need to check the cash flows in South Korean won

When we invest in US we will be getting g cash flows in USD so we are not worried . Here as we move forward we expect that the South Korean won is going to appreciate against USD that means in the future the cash flows which we receive are going to increase as compared to the one anticipated with the spot rate

Let me make an example -

Today let the spot rate is be 1USD = 1100 South Korean Won

Now let us assume we get a cash flow of 11,000 South Korean won in 1 year '

we will discount this using the present spot rate then we get 11,000/1100 = 10 USD

Let the south korean won appreciated so that 1USD = 1000 South Korean won

Now when we find the cash flows using this rate we get 11,000/1000 = 11 USD

So we can see that if South korean won increased we get more USD

Hence going forward of the south korean won appreciated the positivity of NPV will increase and we are more likely to accept the project