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Your US-based firm is considering investing in a project run by its Canadian subsidiary. This project...

Your US-based firm is considering investing in a project run by its Canadian subsidiary. This project will cost CAD 26M to set up today and will pay out CAD 29M in one year. This project will be all equity financed, with the parent firm taking a 70% equity stake, and the Canadian subsidiary will be taking a 30% equity stake. The spot rate is currently USD 0.77 per CAD, and you expect that it will be USD 0.84 per CAD in one year. Your USD discount rate for projects in First World foreign countries is 14%, and your Canadian subsidiary’s discount rate for domestic projects is 13%

5A. What is the NPV of this project from the parent perspective?

5B. What is the NPV of this project from the project perspective?

5C. You believe that the payout for this project could be CAD 1M higher or lower than expected, and that the exchange rate one year from today could be USD 0.12 per CAD higher or lower than expected. If you are concerned about reducing the chance of making a negative NPV investment for the parent firm, should you concentrate on eliminating exchange rate risk or boosting sales?

Solutions

Expert Solution

Casfflows for Parent and Subisdiary Company

Total Parent (70%) Subsidiary (30%)
Cost             2,60,00,000               1,82,00,000                 78,00,000
Cash Inflow             2,90,00,000               2,03,00,000                 87,00,000

Part 5A

NPV from Parents Perpective @ 14%

CAD Ech. Rate US$ PVF Present Value
Cost       1,82,00,000.00           0.77         1,40,14,000.00                       1.0000 $1,40,14,000.00
Cash Inflow       2,03,00,000.00           0.84         1,70,52,000.00                       0.8772 $1,49,57,843.88
Net Present Value $9,43,843.88

Part 5B

NPV from Subsidiary's Perspective@13%

CAD PVF Present Value (in CAD)
Cost           78,00,000.00                       1.0000                              60,06,000.00
Cash Inflow           87,00,000.00                       0.8772                              64,10,504.52
Net Present Value                                4,04,504.52

Part 5C

The NPV from Parent's perspective is $943,843.88

If the cash inflow falls by CAD 1,000,000 then the NPV will fall by $736,839.60 (1,000,000 * 0.8722 * 0.84) and will still be positive.

But if the excange rate fall to $0.96 per CAD then the NPV will fall by $842,102.40 (1,000,000 * 0.8722 * 0.96).

So, we should worry about the falling exchange rate more.

jeff jeffy answered 1 year ago
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