Question

Case 2 Geo Tech Cash Flow Template (Base Case)
Year				0	1	2	3	4	5
					$600,000.00	$1,080,000.00	$1,050,000.00	$750,000.00	$570,000.00
Revenues
Cash Costs
Set up					$280,000.00	$420,000.00	$280,000.00	$140,000.00	$140,000.00
Other operating					$240,000.00	$240,000.00	$360,000.00	$360,000.00	$240,000.00
Depreciation					$280,000.00	$280,000.00	$280,000.00
EBIT					-$200,000.00	$140,000.00	$130,000.00	$250,000.00	$190,000.00
Taxes					-$70,000.00	$49,000.00	$45,500.00	$87,500.00	$66,500.00
Net Operating Income After Taxes					-$130,000.00	$91,000.00	$84,500.00	$162,500.00	$123,500.00
Add Depreciation					$280,000.00	$280,000.00	$280,000.00
Net Operating Cash Flows					$150,000.00	$371,000.00	$364,500.00	$162,500.00	$123,500.00
Recovery of Capital Assets (AT)									$65,000.00
Project Cost				-$840,000.00
Total Cash Flow (CAD)				-$840,000.00	$150,000.00	$371,000.00	$364,500.00	$162,500.00	$188,500.00
Exchange Rate				0.860	0.860	0.860	0.860	0.860	0.860
Total Cash Flow (USD)				-$722,400.000	$129,000.000	$319,060.000	$313,470.000	$139,750.000	$162,110.000

Adjust with below FX rates and inflation, calculate NPV and IRR with FX rates and inflation. Note the base case has been solved. Just looking for adjustments to the last 3 rows with below inflation and FX rates. Show on Excel.

FX Forecast
Project Year	0	1	2	3	4	5
Calendar Year	2014	2015	2016	2017	2018	2019
FX Rate	0.860	0.825	0.805	0.790	0.780	0.775

US Inflation	1.50%
CAD Inflation	1.75%

Answer 1

NPV of cash-flows involving two countries can be computed using two approaches:

Approach 1 : Home currency approach (considering US as home country):

The net present value under this approach is calculated by (a) converting the foreign-currency cash flows of the project to the domestic currency based on the expected forward exchange rates, and (b) discounting the resultant cash flows based on the domestic currency cost of capital.

I will start the calculations from Total cash-flow (CAD) since the others have already been computed in the question.

Particulares	Year 0	Year 1	Year 2	Year 3	Year 4	Year 5	Workings
Total Cash flow (CAD)	(840,000)	150,000	371,000	364,500	162,500	188,500	(A)
FX rates	0.860	0.825	0.805	0.790	0.780	0.775	(B)
Cash flows in USD	(722,400)	123,750	298,655	287,955	126,750	146,088	(C) = (A)*(B)
Discount factor of USD at 1.5% inflation rate	1	0.99	0.97	0.96	0.94	0.93	(D) = refer working note 1 below
Present value of cash flow in USD	(722,400)	121,921	289,893	275,376	119,422	135,607	(E) =(C)*(D)
Net Present Value (USD)	219,820						Sum of all Present value of cash flow in USD

IRR is the internal rate of return at which rate NPV will be zero. We can do multiple sensitivity by changing the discount factor from 1.5% to a higher rate , stopping at a rate when NPV becomes zero. Here, IRR = 11.689%

Steps:

First , the CAD cash flows are converted to USD based on the forward exchange rates and then the USD cashflows are discounted using the USD inflation rate.

Working note 1:

Discount factor of USD inflation rate of 1.5%

Year 1 = 1/(100%+1.5%)^1=0.985

Year 2 = 1/(100%+1.5%)^2=0.971

Year 3 = 1/(100%+1.5%)^3=0.956

Year 4 = 1/(100%+1.5%)^4=0.942

Year 5 = 1/(100%+1.5%)^5=0.928

Approach 2 : Foreign currency approach (considering Canada as foreign country):

The net present value under this approach is calculated by (a) discounting the foreign currency cash flows basis foreign currency cost of capital and (b) converting the resultant present value of foreign-currency cash flows of the project to the domestic currency based on the expected forward exchange rates

I will start the calculations from Total cash-flow (CAD) since the others have already been computed in the question.

Particulares	Year 0	Year 1	Year 2	Year 3	Year 4	Year 5	Workings
Total Cash flow (CAD)	(840,000)	150,000	371,000	364,500	162,500	188,500	(A)
Discount factor of CAD at 1.75% inflation rate	1.000	0.983	0.966	0.949	0.933	0.917	(B) = refer working note 1 below
Cash flows in CAD	(840,000)	147,420	358,348	346,014	151,606	172,838	(C) = (A)*(B)
FX rates	0.860	0.825	0.805	0.790	0.780	0.775	(D)
Present value of cash flow in USD	(722,400)	121,622	288,470	273,351	118,252	133,949	(E) =(C)*(D)
Net Present Value (USD)	213,245						Sum of all Present value of cash flow in USD

IRR is the internal rate of return at which rate NPV will be zero. We can do multiple sensitivity by changing the discount factor from 1.75% to a higher rate , stopping at a rate when NPV becomes zero. Here, IRR = 11.69%

Working note 1:

Discount factor of CAD inflation rate of 1.75%

Year 1 = 1/(100%+1.75%)^1=0.983

Year 2 = 1/(100%+1.75%)^2=0.966

Year 3 = 1/(100%+1.75%)^3=0.949

Year 4 = 1/(100%+1.75%)^4=0.933

Year 5 = 1/(100%+1.75%)^5=0.917

Conclusion:

As can be seen, NPV under both the approaches are almost the same and so as IRR. This is because, the expected foreign exchange of future years reflects the inflation rates of each of the countries.