Question

Lakonishok Equipment has an investment opportunity in Europe. The project costs €12 million and is expected to produce cash flows of €2.7 million in year 1, €3.1 million in year 2, and €2.8 million in year 3. The current spot exchange rate is $1.3/€. The current risk-free rate in the United States is 5 percent, compared to that in Europe of 3.5 percent. The appropriate discount rate for the project is estimated to be 18 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 €6.5 million. What is the NPV of the project?

A.	-$2,448,215

B.	-$1,920,596

C.	-$1,878,787

D.

$879,402

E.	$2,316,519

Answer 1

NPV = Present value of cash inflows - Present value of cash outflows
	Year 0	1	2	3
Cash flows in Euro	(12,000,000)	2,700,000	3,100,000	9,300,000
Exchange rate as per Interest Rate Parity	1.3	1.31884058	1.337954211	1.357344852
Cash flows in Dollars	(15,600,000)	3,560,870	4,147,658	12,623,307
PVF	1	0.847457627	0.71818443	0.608630873
PV of cash flows	(15,600,000)	3,017,686	2,978,783	7,682,934
NPV	(1,920,596)
Hence, the answer is B. -$1,920,596