Question

You are analyzing a project with an initial cost of £48,000. The project is expected to return £11,000 the first year, £36,000 the second year and £38,000 the third and final year. There is no salvage value. The current spot rate is £0.6211. The nominal return relevant to the project is 12 percent in the U.S. The nominal risk-free rate in the U.S. is 4 percent while it is 5 percent in the U.K. Assume that uncovered interest rate parity exists. What is the net present value of this project in U.S. dollars?

Answer 1

Ans.

E(S1) = 0.6211 * [1 + (0.05 - 0.04)]1 = 0.627311
E(S2) = 0.6211 * [1 + (0.05 - 0.04)]2 = 0.63358411
E(S3) = 0.6211 * [1 + (0.05 - 0.04)]3 = 0.639919951
CF0 = - £ 48,000 * ($1/£0.6211) = - $77,282.24
CF1 = £11,000 * ($1/£0.627311) = $17,535.16
CF2 = £36,000 * ($1/£0.63358411) = $56,819.61
CF3 = £38,000 * ($1/£0.639919951) = $59,382.43

Net Present Value = Present Value of Cash Inflows - Present Value of cash outflows

Years (a)	Cash Flows (b)	Present value factor @ 12% ©	Present Value (d = b*c)
0	$      (77,282.24)	1	$    (77,282.24)
1	$         17,535.16	0.892857143	$      15,656.39
2	$         56,819.61	0.797193878	$      45,296.25
3	$         59,382.43	0.711780248	$      42,267.24
	Net Present Value	$      25,937.64

The net present value of this project in U.S. dollars = $ 25,938