Question

You are evaluating a proposed expansion of an existing subsidiary located in Switzerland. The cost of the expansion would be SF 15 million. The cash flows from the project would be SF 4.1 million per year for the next five years. The dollar required return is 11 percent per year, and the current exchange rate is SF 1.06. The going rate on Eurodollars is 4 percent per year. It is 3 percent per year on Euroswiss. Use the approximate form of interest rate parity in calculating the expected spot rates.

a. Convert the projected franc flows into dollar flows and calculate the NPV. (Do not round intermediate calculations and enter your answer in dollars, not in millions, rounded to two decimal places, e.g., 1,234,567.89)

b-1. What is the required return on franc flows? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)

b-2. What is the NPV of the project in Swiss francs? (Do not round intermediate calculations and enter your answer in francs, not in millions, rounded to two decimal places, e.g., 1,234,567.89)

b-3. What is the NPV in dollars if you convert the franc NPV to dollars? (Do not round intermediate calculations and enter your answer in dollars, not in millions, rounded to two decimal places, e.g., 1,234,567.89)

Answer 1

	Year (n)	0	1	2	3	4	5
	Interest rate Eurodollar (Id)		4%	4%	4%	4%	4%
	Interest rate Euroswiss (Is)		3%	3%	3%	3%	3%
S0*[1 + (Is - Id)]^n	Spot rate (SF/$)	1.0600	1.0494	1.0389	1.0285	1.0182	1.0080
	Cash flow (CF) in SF	(15,000,000)	4,100,000	4,100,000	4,100,000	4,100,000	4,100,000
(CF/S)	Cash Flow (CF) in $	(14,150,943.40)	3,906,994.47	3,946,459.06	3,986,322.29	4,026,588.17	4,067,260.78
	Discount factor @ 11%	1.000	0.901	0.812	0.731	0.659	0.593
(CF*Discount Factor)	PV of CF (in $)	(14,150,943.40)	3,519,814.84	3,203,034.71	2,914,764.50	2,652,438.35	2,413,721.31
Sum of all PVs	NPV (in $)	552,830.31

a). NPV (in $) = 552,830.31

b-1). Required return (in SF) = [(1+required return in dollars)*(1+ (Is - Id)] -1

= [(1+11%)*(1 + (3% - 4%))] -1 = 9.89% (Answer)

b-2). NPV (in SF):

Initial investment = 15,000,000

PMT = 4.1 million, N = 5, I/Y = 9.89%, solve for PV. PV = 15,586,000.13

NPV (in SF) = -15,000,000 + 15,586,000.13 = 586,000.13 (Answer)

b-3). NPV (in $) = NPV (in SF)/spot rate = 586,000.13/1.06 = 552,830.31 (Answer)