Question

Marcus Co., a U.S. company, has decided to undertake a 2-year project in Canada. The project is expected to generate 18,000,000 Canadian dollars (C$) in the first year and C$40,000,000 in the second. Marcus will need to invest $35,000,000 at the start of the project. Marcus has decided to use a cost of capital of 14 percent, which it uses for similar projects. The spot rate of the Canadian dollar is expected to be $.79 for the first year and $.82 for the second year. (1) What is the net present value of the project in U.S. dollars?​ (2) Would a stable exchange rate of $.79 for both years be to the advantage or disadvantage of Marcus? Explain.

Answer 1

1)Calculation of the NPV :-

First we convert Canadian dollars to us dollars

years	Cash inflows in Canadian dollars	Spot rate	Cash inflows US dollars
1	C$ 18,000,000	$0.79	$14,220,000
2	C$ 40,000,000	$0.82	$32,960,000

NPV := present value of cash inflows in us dollars - Initial investment in us dollars

present value of cash inflows :-

years	Cash inflows US dollars	PVF@14%	PV of CF
1	$14,220,000	0.877192982	$12,473,684.2105263
2	$32,960,000	0.769467528	$25,361,649.7383810
PV of Cash inflows in US dollars	$37,835,333.9489074

NPV = $ 37,835,333.9489074 - $ 35,000,000

NPV in US dollars = $ 2,835,333.95

2) If spot exchange rate is Stable of both years is $ 0.79 then NPV :-

First we convert canadian dollars to us dollars

years	Cash inflows in Canadian dollars	Spot rate	Cash inflows US dollars
1	C$ 18,000,000	$0.79	$14,220,000
2	C$ 40,000,000	$0.79	$31,600,000

NPV := present value of cash inflows in us dollars - Initial investment in us dollars

present value of cash inflows :-

years	Cash inflows US dollars	PVF@14%	PV of CF
1	$14,220,000	0.877192982	$12,473,684.2105263
2	$31,600,000	0.769467528	$24,315,173.8996614
PV of CF in Us dollars	$36,788,858.1101878

NPV = $ 36,788,858.1101878 - $ 35,000,000

NPV in US dollars = $ 1,788,858.1101878

Here NPV is positive, so if exchange rate is stable for both years then the project is advantageous.