Question

You are evaluating a proposed expansion of an existing subsidiary located in Switzerland. The cost of the expansion would be SF 21 million. The cash flows from the project would be SF 5.9 million per year for the next five years. The dollar required return is 14 percent per year, and the current exchange rate is SF 1.11. The going rate on Eurodollars is 4 percent per year. It is 2 percent per year on Euroswiss. Use the approximate form of interest rate parity in calculating the expected spot rates.

a.	Convert the projected franc flows into dollar flows and calculate the NPV. (Enter your answer in dollars, not in millions of dollars, e.g., 1,234,567. Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)

NPV

$

b-1.	What is the required return on franc flows? (Enter your answer as a percent rounded to 2 decimal places, e.g., 32.16. Do not round intermediate calculations.)

Return on franc flows

%

b-2.	What is the NPV of the project in Swiss francs? (Enter your answer in francs, not in millions of francs, e.g., 1,234,567. Round your answer to 2 decimal places, e.g., 32.16. Do not round intermediate calculations.)

NPV

SF

b-3.	What is the NPV in dollars if you convert the franc NPV to dollars? (Enter your answer in dollars, not in millions of dollars, e.g., 1,234,567. Round your answer to 2 decimal places, e.g., 32.16. Do not round intermediate calculations.

NPV

$

  

Answer 1

ANSWER:

(a)	we need to calculate the expected spot rates for the next 5 years using IRP -
	As per IRP -
	F/S =	(1+ia)/(1+ib)
	F =	Expected spot rate =	(1+ia)/(1+ib)	x S
	Year	Calculation	Expected Spot rate
	1	(1.02/1.04)x1.11	1.088654
	2	(1.02/1.04)^2 x1.11	1.067718
	3	(1.02/1.04)^3 x1.11	1.047185
	4	(1.02/1.04)^4 x1.11	1.027047
	5	(1.02/1.04)^5 x1.11	1.007296
	NPV in Dollar -
	Year	Cash flow(SF)	Expected Spot rate	Cash flow($) =SF/Rate	PV factor @ 14%	PV of cashflows
	0	-21000000	1.11	-18918919	1	-18918919
	1	5900000	1.088654	5419537.2	0.877193	4753980
	2	5900000	1.067718	5525802.6	0.769468	4251925.7
	3	5900000	1.047185	5634151.7	0.674972	3802891.9
	4	5900000	1.027047	5744625.3	0.59208	3401279.3
	5	5900000	1.007296	5857265	0.519369	3042079.9
					NPV =	333237.85
(b)	Risk premium on return =			1.14/1.04
				1.0961538
	Required return on SF =			1.02 x 1.09615
				1.1180769
				1.118077-1
				11.8077%
(c )	NPV in SF -
	Year	Cash flow(SF)	PV factor @ 11.8077%	PV of cashflows
	0	-21000000	1	-21000000
	1	5900000	0.894393	5276917.8
	2	5900000	0.799939	4719637.5
	3	5900000	0.715459	4221210
	4	5900000	0.639902	3775420
	5	5900000	0.572324	3376708.7
			NPV =	369894.02
(d)	NPV in SF =	(At t=0)		369894.02
	Spot rate =			1.11
	NPV in $ =	369894.02 / 1.11 =		333237.85