Question
In: Accounting
4. A project in Hong Kong costs Hong Kong dollar (HKD) 100,000 and produces cash flows...
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?
Solutions
Expert Solution
| 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. | ||||||
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