Question

Foreign Capital Budgeting

The South Korean multinational manufacturing firm, Nam Sung Industries, is debating whether to invest in a 2-year project in the United States. The project's expected dollar cash flows consist of an initial investment of $1 million with cash inflows of $700,000 in Year 1 and $600,000 in Year 2. The risk-adjusted cost of capital for this project is 12%. The current exchange rate is 1,054 won per U.S. dollar. Risk-free interest rates in the United States and S. Korea are:

	1-Year	2-Year
U.S.	4.0%	4.75%
S. Korea	3.0%	3.75%

1. If this project were instead undertaken by a similar U.S.-based company with the same risk-adjusted cost of capital, what would be the net present value generated by this project? Do not round intermediate calculations. Round your answer to the nearest dollar.

   $  

   What would be the rate of return generated by this project? Do not round intermediate calculations. Round your answer to two decimal places.

       %

2. What is the expected forward exchange rate 1 year from now? (Hint: Take the perspective of the Korean company when identifying home and foreign currencies and direct quotes of exchange rates.) Do not round intermediate calculations. Round your answer to two decimal places.

      won per U.S. dollar

   What is the expected forward exchange rate 2 years from now? (Hint: Take the perspective of the Korean company when identifying home and foreign currencies and direct quotes of exchange rates.) Do not round intermediate calculations. Round your answer to two decimal places.

      won per U.S. dollar

3. If Nam Sung undertakes the project, what is the net present value and rate of return of the project for Nam Sung? Do not round intermediate calculations. Enter your answer for the net present value in millions. For example, an answer of 1.23 million won should be entered as 1.23, not 1,230,000. Round your answers to two decimal places.

   NPV:  million won

   Rate of return:   %

Answer 1

From the above we get:

	Y0	Y1	Y2
Initial Investment	1,000,000
Cash Flow	-	700,000	600,000

Risk free rates	1-year	2-year
US	4%	4.75%
S.Korea	3%	3.75%

Risk adjusted cost of capital	12%
Exchange rate	1054

a.) If this project would have been undertaken by similar US company, the Net Present Value (NPV) generated would be:

Net Present Value (NPV) - It is nothing but current value of all the future cash flow generate from a project. The formula to arrive at NPV is:

Where is the initial investment and is the cash flow generated during future period.

Therefore, NPV for above project is:

Rate of return would be: = 10.33%

b.) Calculating Forward exchange rate:

> ! year Forward rate

> 2 year forward rate

c.) If Nam Sung Undertakes this project, NPV would be:

Initial Investment in Won = 1054 million won

Cash Flow 1 = 700,000*1043.86 = 730.71 million won

Cash Flow 2 = 600,000*1043.93 = 626.36 million won

NPV = million won

Rate of return = 97.75/1054 = 9.27%