Question

Annie, a wealthy Houstonian, invests $3.0 million in a mining venture in Mexico. The on-going concern has generated free cash flows of MXP21 million per year, and American geologists project that it will continue to do so for the next three years. Annie requires a rate of return of 20 percent in USD. The current spot rate is $0.08/MXP, and currently nominal interest rates on one-to-three year government securities in the U.S are: 1%, 2% and 3.0%. In Mexico they are: 5%, 8%, and 12%. Hint: To display 4 decimals, “2nd function, DISP 4.”

Annie’s aunt, Coseta, also invested in the same venture, but did not hedge. Ex post, she bought USD at the following spot exchange rates in years one through three: $0.05, $0.04, and $0.03.

9) What was her USD cash inflow for year 1?

*a. $1,050,000

b. 1,400,000

c. 960,000

d. 840,000.

10) What was her USD cash inflow for year 2?

a. $1,050,000

b. 1,400,000

c. 960,000

* d. 840,000

e. 630,000.

11) What was her USD cash inflow for year 3?

a. $1,050,000

b. 1,400,000

c. 960,000

d. 850,000

*e. 630,000

12) Which of the following NPVs would Coseta have earned, if she also requires a 20% rate of return?

A) -$1,419,578

B) -$1,299,263

C) -$1,410,000

D) -$1,539,371

*E) -$1,177,083.

13) Which IRR would Coseta have earned?

a. 18%

b. 12

c. -5.67

*d. -8.93

e. – 7.77.

14) Coseta would have been better-off placing her $3 million in a U.S. bank savings account.

A) TRUE

B) FALSE

I NEED STEP BY STEP SOLUTION!!

Answer 1

9) USD cash flow in year 1 = MXP21 million * USD 0.05/MXP =USD 1.05 million = USD 1,050,000 (option a)

10. USD cash flow in year 2 = MXP21 million * USD 0.04/MXP =USD 0.84 million = USD 840,000 (option d)

11. USD cash flow in year 3= MXP21 million * USD 0.03/MXP =USD 0.63 million = USD 630,000 (option e)

12.

NPV@20% (in million USD)= -3 + 1.05/1.2+0.84/1.2^2+0.63/1.2^3= -1.1770833 or -USD1.177083million (option e)

13. IRR (r) is given by the discount rate at which NPV=0

-3+1.05/(1+r)+0.84/(1+r)^2+0.63/(1+r)^3=0

Using hit and trial method (r is negative as the principal amount also has not been recovered)

If r= -0.1 , Left hand side of equation = 0.0679

r= -0.09 , Left hand side of equation = 0.0042

r= -0.085 , Left hand side of equation = -0.026755

Using linear approximation,

r= -0.09+(0.0042-0)/(0.0042-(-0.026755))*(-0.085-(-0.09)) = -0.08932

r= -0.08932 , Left hand side of equation = 0

So, this is the correct value and IRR = -8.93% (option d)

f) If Coseta had put her amount in US bank savings, her IRR would have been positive, but she has eaned negative returns(lost) on this investment . Hence , putting amount in US bank savings would have been better.

A) TRUE is correct