Question

Lakonishok Equipment has an investment opportunity in Europe. The project costs €12 million and is expected to produce cash flows of €2.1 million in Year 1, €2.5 million in Year 2, and €3.6 million in Year 3. The current spot exchange rate is $1.36 / €; and the current risk-free rate in the United States is 2.9 percent, compared to that in Europe of 2.1 percent. The appropriate discount rate for the project is estimated to be 15 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 €9.1 million. Use the exact form of interest rate parity in calculating the expected spot rates.

  

What is the NPV of the project in U.S. dollars? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16. Enter your answer in dollars, not in millions, e.g., 1,234,567.)

Answer 1

The formula to calculate risk adjustment spot rate is given below:

Here,

n is number of year.

Risk adjusted spot rate for year 1 is calculated below:

Risk adjusted spot rate for year 2 is calculated below:

Risk adjusted spot rate for year 3 is calculated below:

The cash flows for each year is given, but net cash flow should be calculated with the help of using risk adjusted spot rate.

Net cash flow in year 0 is calculated below:

Net cash flow in year 1 is calculated below:

Net cash flow in year 2 is calculated below:

Net cash flow in year 3 is calculated below:

The net present value for the investment is calculated below:

The NPV of the project in US dollar is $419,942.32.