Delta Company, a U.S. MNC, is contemplating making a foreign capital expenditure in South Africa. The...

Delta Company, a U.S. MNC, is contemplating making a foreign capital expenditure in South Africa. The initial cost of the project is ZAR12,000. The annual cash flows over the five year economic life of the project in ZAR are estimated to be 3,500; 4,500; 5,500; 6,500; and 7,500. The parent firm’s cost of capital in dollars is 8.5%. Long-run inflation is forecasted to be 3.5% per annum in the U.S. and 7.25% percent in South Africa. The current spot foreign exchange rate is ZAR/USD = 3.75.

a. Determine the NPV for the project in USD.

b. . Determine the NPV for the project in ZAR.

c. What is the NPV in dollars if the actual pattern of ZAR/USD exchange rates is: S(0) = 3.75, S(1) = 5.7, S(2) = 6.7, S(3) = 7.2, S(4) = 7.7, and S(5) = 8.2?

Solutions

Expert Solution

Step 1

DEtermination of Forward Exchange Rates based on Inflation Rate parity Theory

As per this theory,

Year	1	2	3	4	5
Opening Rate ZAR / USD (A)	3.75	3.8859	4.0267	4.1726	4.3237
Inflation Rate in South Africa (B)	7.25%	7.25%	7.25%	7.25%	7.25%
Inflation Rate in US (C)	3.5%	3.5%	3.5%	3.5%	3.5%
(D) = (1+B)/(1+C)	103.62%	103.62%	103.62%	103.62%	103.62%
Closing Rate ZAR /USD *(A) (D)**	3.75	3.8859	4.0267	4.1726	4.3237

Step 2

Compuatation of PV Factor

Year	Present Value Factor
0	1
1	0.9217
2	0.8495
3	0.7829
4	0.7216
5	0.6650

ANSWER TO PART 1

Computation of NPV in USD

Year	Inflow / (Outflow) in ZAR (A)	Conversion Rate (B)	Inflow / (Outflow) in USD (C)= (A)/(B)	Present Value Factor	Present VAlue
0	(12000)	3.75	(3200)	1	(3200)
1	3500	3.8859	900.70	.9217	830.13
2	4500	4.0267	1117.55	.8494	949.31
3	5500	4.1726	1318.14	.7829	1031.98
4	6500	4.3237	1503.33	.7216	1084.76
5	7500	4.4804	1673.96	.6650	1113.26
Total	15500		3313.68		1809.46

The NPV of the project in USD is $ 1809.46.

ANSWER TO PART 2

Computation of NPV in ZAR

Year	Inflow / (Outflow) in ZAR(A)	Present Value Factor (B)	Present VAlue = *(A)(B)**
0	(12000)	1	(12000)
1	3500	.9217	3225.80
2	4500	.8494	3822.55
3	5500	.7829	4305.99
4	6500	.7216	4690.23
5	7500	.6650	4987.84
Total	15500		9032.41

The NPV is ZAR 9032.41

ANSWER TO PART 3

COMPUTATION OF NPV according to ACTUAL EXCHANGE RATES

Year	Inflow / (Outflow) in ZAR (A)	Conversion Rate (B)	Inflow / (Outflow) in USD (C)= (A)/(B)	Present Value Factor	Present VAlue
0	(12000)	3.75	(3200)	1	(3200)
1	3500	5.70	614.04	.9217	565.93
2	4500	6.70	671.64	.8494	570.53
3	5500	7.20	763.89	.7829	598.05
4	6500	7.70	844.16	.7216	609.12
5	7500	8.20	914.63	.6650	608.27
Total	15500		608.36		(248.09)

IN this case, the NPV is negative; $ - 248.09

ekkarill92 answered 1 year ago

Next > < Previous

Related Solutions

Delta Company, a U.S. MNC, is contemplating making a foreign capital expenditure in South Africa.

Delta Company, a U.S. MNC, is contemplating making a foreign capital expenditure in South Africa. The initial cost of the project is ZAR10,000. The annual cash flows over the five-year economic life of the project in ZAR are estimated to be 3,000, 4,000, 5,000, 6,000, and 7,000. The parent firm’s cost of capital in dollars is 9.5 percent. Long-run inflation is forecasted to be 3 percent per annum in the United States and 7 percent in South Africa. The...

An Australian company is considering making a foreign capital expenditure in New Zealand. The cost of...

An Australian company is considering making a foreign capital expenditure in New Zealand. The cost of the project is NZD 1m and it is expected to generate cash flows of NZD 350,000, NZD 300,000 and NZD 650,000 over three years. The inflation rate in New Zealand is 3.2%pa and the inflation rate in Australia is 4.1%pa. The inflation rates are forecasted to be unchanged over the investment horizon. The firm's cost of capital in Australian dollars is 12.5%. The current...

What are the costs and benefits to South Africa of having more foreign direct investment? Of...

What are the costs and benefits to South Africa of having more foreign direct investment? Of having less?

Question 5 [10]A large share of the growing expenditure in South Africa goes towards the remuneration...

Question 5 [10]A large share of the growing expenditure in South Africa goes towards the remuneration of employees (the so-called wage bill). Explain how unbalanced productivity growth (According to Baumol’s unbalanced productivity growth model) affects government expenditure, and briefly comment on its relevance to South Africa. Subject: Government economics 20A

The management of Faulu Limited is contemplating to invest in 8 projects. The capital expenditure during...

The management of Faulu Limited is contemplating to invest in 8 projects. The capital expenditure during the year has been rationed to sh.500,000 and the projects have equal risk and should be discounted at the firm’s cost of capital of 10% Project Cost (sh.) Project life (years) Cash flow per year (sh.) A B C D E F G H 400,000 50,000 100,000 75,000 75,000 50,000 250,000 250,000 20 10 8 15 6 5 10 3 58600 55000 24000 12000...

Kenya and South Africa are trading partners, and there are capital flows between the two countries....

Kenya and South Africa are trading partners, and there are capital flows between the two countries. The currency in Kenya is the Kenyan shilling (Ksh.) and the currency in South Africa is the South African Rand (R). Assume that the equilibrium exchange rate is 0.14R per Kenya shilling. Now suppose that the opportunity cost of consumption falls in South Africa. Referring to the Kenyan foreign exchange market, explain how the equilibrium exchange rate might change. You are not required to draw...

Suppose that South Africa and Japan are major trading partners, and that capital flows occur between...

Suppose that South Africa and Japan are major trading partners, and that capital flows occur between the two countries. The currency in South Africa is the South African Rand (R) and the currency in Japan is the Japanese Yen (¥). Assume that the equilibrium exchange rate in South Africa is 0.1R per ¥. Now suppose that (ceteris paribus) the cost of borrowing rises in Japan. a. Using TWO separate graphs of the South African foreign exchange market, with each graph...

??A? U.S.-based MNC has a foreign subsidiary that earns $ 252000 before local? taxes, with all...

??A? U.S.-based MNC has a foreign subsidiary that earns $ 252000 before local? taxes, with all the? after-tax funds to be available to the parent in the form of dividends. The applicable taxes consist of a 33 % foreign income tax? rate, a foreign dividend withholding tax rate of 9.6 %?, and a U.S. tax rate of 30 %. Calculate the net funds available to the parent MNC? if: a.??Foreign taxes can be applied as a credit against the? MNC's...

Cost of Capital. Blues, Inc. is an MNC located in the U.S. Blues would like to...

Cost of Capital. Blues, Inc. is an MNC located in the U.S. Blues would like to estimate its weighted average cost of capital (WACC). On average, bonds issued by Blues yield 7 percent. Currently, Treasury security rates are 2 percent. Furthermore, Blues’ stock has a beta of 2, and the return on the Wilshire 5000 stock index is expected to be 8 percent. Blues’ target capital structure is 40 percent debt and 60 percent equity. If Blues is in the...

KG is a divisionalised company, based in South Africa, where it is quoted on the stock...

KG is a divisionalised company, based in South Africa, where it is quoted on the stock exchange. KG manufactures and sells small electrical equipment products. South Africa is more highly developed than the neighbouring countries. KG has enjoyed a strong home market and has exported to the neighbouring countries. KG has had a reputation for producing high quality products. Recently, it has come under increasing competitive pressure from new, privately held, companies based in the neighbouring countries. It appears that...

Subjects