Question

You work for a California textbook company. Henry is auctioning off the rights to his online textbooks sales in Switzerland, which are expected to bring in the following EUR cash flows over the next three years:

                                       Year 1 Year 2 Year 3

EUR Cash Flows 1,000 1,100 1,200

To prepare your bid, you need to calculate the net present value (NPV) of these cash flows in USD terms. You believe that relative PPP is a reasonable tool to use.

The spot exchange rate is 1.20 USD per EUR. Expected US inflation is 2%, and expected inflation in Switzerland is 1%. Your USD discount rate is 9%.

The NPV of these cash flows in USD is: ????

You have a Brazilian partner, who ask for your estimates of the net present value of the EUR cash flows in Brazilian real (BRL) terms.

He asks you to convert the cash flows into BRL (using relative PPP), and to use a BRL discount rate of 25%.

The spot exchange rate is 4 BRL per USD. Expected BRL inflation is 12%. All other information is the same as above.

The NPV of these cash flows in BRL terms is: ????

Answer 1

	Current Spot Exchange rate (Year0)	$1.20	per EUR
	Exchange Rate in Year1:
	US Inflation rate =2%=0.02
	Switzerland inflation rate=1%=0.01
	For Purchasing Power Parity:
	Expected exchange Rate in Year 1:
	1.2*1.02 US dollar=1*1.01 EUR
	Expected exchange Rate in Year 1:	$1.2119	per EUR	(1.2*(1.02/1.01)
	Expected exchange Rate in Year 2:	$1.2239	per EUR	(1.2119*(1.02/1.01)
	Expected exchange Rate in Year 3:	$1.2360	per EUR	(1.2239*(1.02/1.01)
	Present Value of Cash Flow:
	(Cash Flow)/((1+i)^N
	i=USD discount rate =9%=0.09
	N= Year of Cash flow
	CASH FLOWS
		N	A	B	CF=A*B	PV=CF/(1.09^N)
		Year	EUR Cash Flow	Expected Exchange Rate (USD/EUR)	USD Cash Flow	Present Value of USD Cash Flow
		1	100	$1.2119	$121.19	$111.18
		2	1100	$1.2239	$1,346.27	$1,133.13
		3	1200	$1.2360	$1,483.20	$1,145.30
					SUM	$2,389.61
	NPV of these cash flows in USD is	$2,389.61
	NPV in BRL Terms
	Current Spot Exchange rate (Year0)	BRL 4	per USD
	Current Spot Exchange rate (Year0)BRL	4.80	per EUR	(4*1.2)
	Exchange Rate in Year1:
	BRL Inflation rate =12%=0.12
	Switzerland inflation rate=1%=0.01
	Expected exchange Rate in Year 1:BRL	5.3228	per EUR	(4.8*(1.12/1.01)
	Expected exchange Rate in Year 2:BRL	5.9025	per EUR	(5.3228*(1.12/1.01)
	Expected exchange Rate in Year 3:BRL	6.5453	per EUR	(5.9025*(1.12/1.01)
	Present Value of Cash Flow:
	(Cash Flow)/((1+i)^N
	i=BRL discount rate =25%=0.25
	N= Year of Cash flow
	CASH FLOWS
		N	A	B	CF=A*B	PV=CF/(1.25^N)
		Year	EUR Cash Flow	Expected Exchange Rate (BRL/EUR)	BRL Cash Flow	Present Value of USD Cash Flow
		1	100	5.3228	532.28	425.82
		2	1100	5.9025	6,492.73	4,155.35
		3	1200	6.5453	7,854.39	4,021.45
					SUM	8,602.62
	NPV of these cash flows in BRL Terms is	8,602.62