Question

Suppose that Apple is analyzing a project of opening a plant in Malaysia to build its smart electric cars. Apple projects cash flows of (Malaysian Ringgit) MR 10 million for 4 years and a Terminal value of 28 M as Apple doesn’t intend to stay in the car industry for long, instead Apple will sell the project at the end of year 4 at a cash flow of 28 M. The initial investment is evaluated at MR25 million. The Financial manager collected the following data:

• Exchange rate S₀ ($/MR) is $0.25
• Expected inflation rate in Malaysia is 4%
• Expected inflation rate in the US is 2%
• The WACC (discount rate to be used for US local investment is 15%

1. Calculate the NPV of this project using the home country approach ($NPV)

2. What should be the appropriate discount rate to use in the foreign country approach?

3.Calculate the NPV using the foreign country approach (MR NPV)

Answer 1

Solution:

Part A )

In home country approach we calculate the cash flow in foreign currency then calculate the future exchange rate based on the inflation

Formula is Future = Spot * ( 1+ interest in US) / (1+ interest in Malasia)

Now convert the cash flow of each year in USD based on the future exchnage rate and discount it to get the NPV

NPV = $4.28 Million

Part B ) In foreign currency approach WACC = WACC in home currency approach + Interest rate differenctial = 15% + 4% -2% = 17%

Part C )

In foreign currency approach we calculate the NPV in Foreign currency and based on the spot rate we convert it to home currency

NPV = 4.34 Million

Ideally this should be equal to home currency approach but there is some difference due to round off issue