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 0.74 Swiss franc. In addition, 1-year risk-free securities in the United States are yielding 6.5%, 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.

a.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=?

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

SF per U.S. $= ?

c.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

Part 1)

The values of NPV and rate of return are arrived as below:

NPV = -Initial Investment in USD + Cash Inflow Year 1 in USD/(1+Risk-Adjusted Cost of Capital)^1 = -2,000 + 2,400/(1+12%)^1 = $142.86

Rate of Return = Cash Inflow Year 1 in USD/Initial Investment in USD - 1 = 2,400/2,000 - 1 = 20%

______

Part 2)

The forward exchange rate one year from now is determined as follows:

Forward Exchange Rate 1 Year from Now (Swiss Francs) = Spot Exchange Rate*((1+1 Year Risk-Free Rate _Swiss)/(1+1 Year Risk-Free Rate _US))

Substituting values in the above formula, we get,

Forward Exchange Rate 1 Year from Now (Swiss Francs) = .74*((1+4.5%)/(1+6.5%)) = .726 Swiss franc. or .73 Swiss franc.

SF per U.S. $ = .73

______

Part 3)

The values of NPV and rate of return are arrived as below:

NPV = -Initial Investment in Swiss franc. + Cash Inflow Year 1 in Swiss franc./(1+Risk-Adjusted Cost of Capital)^1 = -2,000*.74 + (2,400*.726)/(1+12%)^1 = 75.94 Swiss franc.

Rate of Return = ((Cash Inflow Year 1 in Swiss franc)/(Initial Investment in Swiss franc.)) - 1 = ((2,400*.726)/(2,000*.74)) - 1 = 17.75%