Question

Lakonishok Equipment has an investment opportunity in Europe. The project costs €9 million and is expected to produce cash flows of €1.8 million in year 1, €3.7 million in year 2, and €4.1 million in year 3. The current spot exchange rate is $1.21/€; the current risk-free rate in the United States is 5 percent, compared to that in Europe of 4.6 percent. The appropriate discount rate for the project is estimated to be 10 percent, the U.S. cost of capital for the company. In addition, the subsidiary can be sold at the end of three years for an estimated €8.2 million. What is the NPV of the project? Multiple Choice

$6,381,974.92

$739,338.40

$6,136,514.35

$5,891,053.78

$5,808,832.55

Answer 1

NPV = present value of cash inflows - Present value of cash outflows
Year	0	1	2	3	3
Cash flows In Euro	(9,000,000.00)	1,800,000.00	3,700,000.00	4,100,000.00	8,200,000.00
Exchange rate	1.21000	1.21463	1.21927	1.22393	1.22393
Cash flows in Dollars	(10,890,000.00)	2,186,328.87	4,511,306.39	5,018,131.88	10,036,263.76
PVF	1.000000	0.909091	0.826446	0.751315	0.751315
PV of cash flows	(10,890,000.00)	1,987,571.70	3,728,352.39	3,770,196.75	7,540,393.51
NPV	6,136,514.35
Hence, the answer is $6,136,514.35

Note: Forward exchange rate as per interest rate parity = Spot rate*(1+Interest rate US)^Number of years/(1+Interest rate Euro)^Number of years