Question

Sandrine Machinery is a Swiss multinational manufacturing company. Currently, Sandrine's financial planners are considering undertaking a 1-year project in the United States. The project's expected dollar-denominated cash flows consist of an initial investment of $2000 and a cash inflow the following year of $2400. Sandrine estimates that its risk-adjusted cost of capital is 12%. Currently, 1 U.S. dollar will buy 0.7 Swiss franc. In addition, 1-year risk-free securities in the United States are yielding 7%, while similar securities in Switzerland are yielding 4.5%. The data has been collected in the Microsoft Excel Online file below. Open the spreadsheet and perform the required analysis to answer the questions below. Do not round intermediate calculations.

1. If this project was instead undertaken by a similar U.S.-based company with the same risk-adjusted cost of capital, what would be the net present value and rate of return generated by this project? Round your answers to two decimal places.

   NPV = $  

   Rate of return = %

2. What is the expected forward exchange rate 1 year from now? Round your answer to two decimal places.

   SF per U.S. $

3. If Sandrine undertakes the project, what is the net present value and rate of return of the project for Sandrine? Do not round intermediate calculations. Round your answers to two decimal places.

   NPV =  Swiss Francs

   Rate of return = %

Answer 1

Answer :-

Cost of Capital {same for Both Countries} : 12%

Initial Investment = $ 2000

Inflow after = 1year = $ 2400

Project life = 1year

SPOT RATE : 1$ = 0.70 SF

1yr US Interest Rate = 7%

1yr SF Interest Rate = 4.50%

IF PROJECT TAKEN IN US (We need not Covert as Figures are already in $) :

NPV = Present Value of Inflow (-) Initial Investment

= 2400 * PVF_{(at 12%,for 1yr)} (-) 2000

= ( 2400*0.893 ) - 2000

= 2086.956 (-) 2000

= $ 142.857

Rate of Return = Rate at which P.V of Inflows are getting Equal to Initial Investment

2000 = 2400 * PVF_{( r% , 1 year )}

Rate = 20%

{IF YOU WANT TO KNOW THE SHORTCUT WAY TO FIND THIS ON CALULATOR, PLEASE LET ME KNOW IN COMMENT}

Now,

CALCULATION NPV & RATE OF RETURN IN SF :

STEP 1 : First Calculate 1year Forward Rates Using IRPT Theoem

Forward Rate = Spot Rate (1+Interest Rate of SF / 1+ Interest Rate of US)

Forward Rate = 0.7 (1.045 / 1.07)

1$ = 0.684 SF

STEP 2 : Convert Cash Inflow after 1 year into SF Using Forward Rate Calculated Above

Cash Inflow in SF = Cash Inflow in $ * FORWARD RATE

= $ 2400 * 0.684

= SF 1,640.75

STEP 3 : Convert Initial OutFlow into SF Using Spot

Cash OutFlow in SF = Outflow in $ * SPOT RATE

= 2000 * 0.70

= SF 1400

STEP 4 : Now Calculate NPV (In SF) Using Discount RATE 12%

NPV = Present Value of Inflow (-) Initial Investment

NPV = SF 1640.75 * PVF_{(at 12%,for 1yr)} - SF 1400

NPV = (SF 1640.75 * 0.8928) - SF 1400

NPV = 1464.953 (-) 1400

NPV = SF 64.953

STEP 5 : Now Calculate Rate of Return (In SF)

Rate of Return = Rate at which P.V of Inflows are getting Equal to Initial Investment

1400 = 1640.75 * PVF_{( 1year , ?% )}

RATE = 17.196% ( approx )

If there is any doubt please ask in comments