An Australian company is considering making a foreign capital expenditure in New Zealand. The cost of...

An Australian company is considering making a foreign capital expenditure in New Zealand. The cost of the project is NZD 1m and it is expected to generate cash flows of NZD 350,000, NZD 300,000 and NZD 650,000 over three years.

The inflation rate in New Zealand is 3.2%pa and the inflation rate in Australia is 4.1%pa. The inflation rates are forecasted to be unchanged over the investment horizon.

The firm's cost of capital in Australian dollars is 12.5%. The current exchange rate is S(NZD/AUD)=1.10. Ignore any tax effects (i.e. assume the tax rate is zero).

Convert all cash flows from NZD to AUD at the PPP forecasted exchange rates and estimate the NPV of the project at the AUD cost of capital. Are the two answers identical? If you find any major deviations between the two answers, try to explain the source of these deviations.

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Expert Solution

jeff jeffy answered 2 years ago

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