Assume that Baps Corporation is considering the establishment of a subsidiary in

Question

Assume that Baps Corporation is considering the establishment of a subsidiary in Norway. The initial investment required by the parent is NOK 44,450.000. If the project Is undertaken. Baps would terminate the project after four years Baps' cost of capital is 1296, and the project is of the same risk as Baps' existing projects. All cash flows generated from the project will be remitted to the parent at the end of each year. Listed below are the estimated cash flows the Norwegian subsidiary will generate over the project's lifetime in Norwegian kroner (NOK): The current exchange rate of the Norwegian kroner is $.135. Baps' exchange rate forecast for the Norwegian kroner over the project's lifetime is listed below: What is the net present value (in US$) of the Norwegian project? What would be the result of the NPV if the funds from the project in year 1, 2, and 3 were blocked and money could not be remitted back to the parent company until year 4. Assume the cash generated by the project from years 1, 2 and 3 can be reinvested into Norway Bonds earning 15% interest per years? NPV would decrease NPV would stay the same c. NPV would increase What 2 factors are influencing the answer you chose in problem 2. What would be the result of the NPV (in problem 1) if the NOK were to depreciate in years 1, 2, 3 and 4 from their present level of $.135/1NOK? NPV would decrease NPV would stay the same NPV would increase

Explanation / Answer

1.NPV is as follows

2.

The return is converted into USD @.15 which willl be $4521937.5

The PV @12% will be = 452197.5*.6355 = $2873773

NPV will increase in such case. If the cash flows were reinvested in US @12% each year the PV of cash flows would have been $1932528.

3. The factors influencing in 2 are inflation rate andnterest rate parity theory. Ideally,both the cahs flows should have been equal in question 2. But the levelof inflation is not evenly applied in both the country currency values which gives an arbitration gain after 4 years.

4.NPV would decrease n such case.

Year NOK Cash Flow Exchnge rate USD PV @12% PV of Cash flows 0 -44450000 0.135 -6000750 1 -6000750 1 10000000 0.145 1450000 0.892857 1294642.857 2 15000000 0.145 2175000 0.797194 1733896.684 3 17000000 0.15 2550000 0.71178 1815039.632 4 20000000 0.15 3000000 0.635518 1906554.235 NPV 749383.408

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