A project in Hong Kong costs Hong Kong dollar (HKD) 200,000 and produces cash fl

Question

A project in Hong Kong costs Hong Kong dollar (HKD) 200,000 and produces cash flows of HKD 75,000 per year for five years. Gruner, a Swiss firm using the Swiss franc (CHF), is interested in adopting this project. If this had been a domestic project, the discount rate would have been 11 percent. Forecasts of inflation rates over the next five years indicate inflation of 1.2 percent in Switzerland and 4 percent in Hong Kong. Spot CHFHKD is 8.0.
What is the appropriate discount rate for HKD cash flows?

Explanation / Answer

Calculation of HKD Cash Flow (in HKD)

Year Cash Inflow Int Rate(11%) PVof CF

0 (2,00,000) 1.00 (2,00,000)

1 75,000 .900 67,500

2 75,000 .812 60,825

3 75,000 .732 54,825

4 75,000 .659 49,425

5 75,000 .594 44,550

Net Cash Flow 77,125 (2,77,125 - 2,00,000)

B) Inflation is 4.00%

Cost increase by = 200000*104% = 2,08,000

Discounting Rate calculate -

ROI increase by = 0.44%

Discounting Factor is = (1/1+11.44)*100

= 8.04%

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