Question

In: Accounting

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?

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 2 years ago

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