Question

Sandrine Machinery is a Swiss multinational manufacturing company. Currently, Sandrine's financial planners are considering undertaking a 1-year project in the United States. The project's expected dollar-denominated cash flows consist of an initial investment of $2000 and a cash inflow the following year of $2400. Sandrine estimates that its risk-adjusted cost of capital is 15%. Currently, 1 U.S. dollar will buy 0.73 Swiss franc. In addition, 1-year risk-free securities in the United States are yielding 6%, while similar securities in Switzerland are yielding 3%. Do not round intermediate calculations.

If this project was instead undertaken by a similar U.S.-based company with the same risk-adjusted cost of capital, what would be the net present value and rate of return generated by this project? Round your answers to two decimal places.

NPV = $ _____

Rate of return = _____

What is the expected forward exchange rate 1 year from now? Round your answer to two decimal places.

_____ SF per U.S. $

If Sandrine undertakes the project, what is the net present value and rate of return of the project for Sandrine? Do not round intermediate calculations. Round your answers to two decimal places.

NPV = ____Swiss Francs

Rate of return = ____%

Answer 1

Answer

Facts Given in Ques :

• Cost of Capital {same for Both Countries} : 15%
• Initial Investment = $ 2000
• Inflow after 1year = $ 2400
• Project life = 1year
• SPOT RATE : 1$ = 0.73 SF
• 1yr US Interest Rate = 6%
• 1yr SF Interest Rate = 3%

Now,

IF PROJECT TAKEN IN US (We need not Covert as Figures are already in $) :

NPV = Present Value of Inflow (-) Initial Investment

= 2400 * PVF_{(at15%,for 1yr)} (-) 2000

= (2400*0.86956521739) - 2000

= 2086.95652 (-) 2000

= $ 86.96

Rate of Return = Rate at which P.V of Inflows are getting Equal to Initial Investment

2000 = 2400 * PVF_{(1year, ?%)}

Rate = 20% approx

{IF YOU WANT TO KNOW THE SHORTCUT WAY TO FIND THIS ON CALULATOR, PLEASE LET ME KNOW IN COMMENT}

Now,

CALCULATION NPV & RATE OF RETURN IN SF :

STEP 1 : First Calculate 1year Forward Rates Using IRPT Theoem

Forward Rate = SpotRate (1+Interest Rate of SF/ 1+ Interest Rate of US)

Forward Rate = 0.73 (1.03/ 1.06)

1$ = 0.71 SF

STEP 2 : Convert Cash Inflow after 1 year into SF Usinf Forward Rate Calculated Above

Cash Inflow in SF = Cash Inflow in $ * FORWARD RATE

= $ 2400 * 0.71

= SF 1704

STEP 3 : Convert Initial OutFlow into SF Usinf Spot

Cash OutFlow in SF = Outflow in $ * SPOT RATE

= 2000 * 0.73

= SF 1460

STEP 4 : Now Calculate NPV (In SF) Using Discount RATE 15%

NPV = Present Value of Inflow (-) Initial Investment

NPV = SF 1704 * PVF_{(at15%,for 1yr)} - SF 1460

NPV = (SF 1704 * 0.86956521739) - SF 1460

NPV = 1481.73914 (-) 1460

NPV = SF 21.74

STEP 5 : Now Calculate Rate of Return (In SF)

Rate of Return = Rate at which P.V of Inflows are getting Equal to Initial Investment

1460 = 1704 * PVF_{(1year, ?%)}

RATE = 16.71% approx

HOPE YOU HAVE UNDERSTOOD THE CONCEPT USED TO SOLVE THIS QUES. STILL IF ANY DOUBT PLEASE ASK IN COMMENT :)