Question

1. Brower, Inc. just constructed a manufacturing plant in Europe. The construction cost 10 million Euros. Brower intends to leave the plant open for three years. During the three years of operation, Euro cash flows are expected to be 1 million euros, 2 million euros, and 3 million euros, respectively. Operating cash flows will begin one year from today and are remitted back to the parent at the end of each year. At the end of the third year, Brower expects to sell the plant for 8 million euros. Brower has a required rate of return of 10 percent. The current exchange rate is $1.18/euro and the Euro is expected to depreciate to $1.15/euro in year 1, $1.14/euro in year 2 and $1.13/euro in year 3.

1. Determine the NPV for this project. Should Brower build the plant?

2. How would your answer change if the value of the euro was expected to appreciate from its current value of $1.18/euro to $1.21/euro in year 1, $1.23/euro in year 2 and $1.25/euro in year 3?

Answer 1

Calculation of Present value
Solution a					10%
	Year	Cash flow in EURO	Ex rate	Cash flow in USD	PV factor, 1/(1+r)^t	PV-Cash Flow-1
	0	€ (10.00)	$     1.18	$ (11.80)	1.0000	$ (11.80)
	1	€     1.00	$     1.15	$     1.15	0.9091	$     1.05
	2	€     2.00	$     1.14	$     2.28	0.8264	$     1.88
	3	€     3.00	$     1.13	$     3.39	0.7513	$     2.55
	3	€     8.00	$     1.13	$     9.04	0.7513	$     6.79
					NPV	$     0.47
	Since the NPV is positive, the plant should be built
Solution b					10%
	Year	Cash flow in EURO	Ex rate	Cash flow in USD	PV factor, 1/(1+r)^t	PV-Cash Flow-1
	0	€ (10.00)	$     1.18	$ (11.80)	1.0000	$ (11.80)
	1	€     1.00	$     1.21	$     1.21	0.9091	$     1.10
	2	€     2.00	$     1.23	$     2.46	0.8264	$     2.03
	3	€     3.00	$     1.25	$     3.75	0.7513	$     2.82
	3	€     8.00	$     1.25	$   10.00	0.7513	$     7.51
					NPV	$     1.66
	Since the NPV is positive, the plant should be built. As compared to
	First option, the NPV is increased from $ 0.47 million USD to $ 1.66 million USD.