Question

4. A project in Hong Kong costs Hong Kong dollar (HKD) 100,000 and produces cash flows of HKD 40,000 per year for four years. Gruner, a Swiss firm using Swiss franc (CHF), is interested in adopting this project. If this had been a domestic project, the discount rate would have been 14 percent, Forecasts of inflation rates over the next four years indicate inflation of 2.5 percent in Switzerland and 5 percent in Hong Kong. Spot CHFHKD is 6.2

a. What is the appropriate discount rate for HKD cash flows? Using this discount rate, calculate the project NPV in HKD.

b. Making appropriate assumptions and using data given in the problem, forecast future values of CHFHKD.

c. Estimate CHF cash flows, and calculate the project NPV in CHF. Are HKD and CHF project NPVs different?

Answer 1

	NPV in HKD
1	Particulars	Amount (HKD)	Discount rate - 14%	Discounted cash flows
	Initial investment ( Year 0)	100000.00	1.00	100000.00
	Cash Flow- Year 1	40000.00	0.88	35087.72
	Year 2	40000.00	0.77	30800.00
	Year 3	40000.00	0.67	26800.00
	Year 4	40000.00	0.59	23600.00
	NPV			-16287.72
2	Caculation of future exchange rate :-
	Future exchange rate	S *	1 + Domestic currency intrest rate
			1 + foreign currency interest rate
	Future exchange rate	6.20	1+0.05
			1+0.025
	Future exchange rate	6.35
3	NPV in CHF
	Particulars	Amount (HKD)	Exchange rate	Amount CHF	Discount rate - 16.25%	Discounted cash flows
	Initial investment ( Year 0)	100000.00	6.20	620000.00	1.00	620000.00
	Cash Flow- Year 1	40000.00	6.35	254000.00	0.86	218440.00
	Year 2	40000.00	6.35	254000.00	0.74	187960.00
	Year 3	40000.00	6.35	254000.00	0.64	162560.00
	Year 4	40000.00	6.35	254000.00	0.55	139700.00
	NPV					-88660.00
	Yes the NPV as per CHF and HKD are different du to exchange rate and inflation.