You are evaluating a proposed expansion of an existing subsidiary located in Swi

Question

You are evaluating a proposed expansion of an existing subsidiary located in Switzerland. The cost of the expansion would be SF16 million. The cash flows from the project would be SF4.2 million per year for the next five years. The dollar required return is 12 percent per year, and the current exchange rate is SF1.07. The going rate on Eurodollars is 5 percent per year. It is 2 percent per year on Swiss francs.

Convert the projected franc flows into dollar flows and calculate the NPV. (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16. Enter your answer in dollars, not in millions, e.g., 1,234,567.)

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.)

What is the NPV of the project in Swiss francs? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16. Enter your answer in francs, not in millions, e.g., 1,234,567.)

What is the NPV in dollars if you convert the franc NPV to dollars? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16. Enter your answer in dollars, not in millions, e.g., 1,234,567.)

You are evaluating a proposed expansion of an existing subsidiary located in Switzerland. The cost of the expansion would be SF16 million. The cash flows from the project would be SF4.2 million per year for the next five years. The dollar required return is 12 percent per year, and the current exchange rate is SF1.07. The going rate on Eurodollars is 5 percent per year. It is 2 percent per year on Swiss francs.

Explanation / Answer

SF Interest Rate = 2 %, $ Interest Rate = 5 %, Current Exchange Rate = SF 1.07 / $

Exchange Rate Projections:

Year 1 = 1.07 x [1.02 /1.05] = 1.039 SF/$, $ Value of Cash Flow = 4.2 / 1.039 = $ 4.04 million

Year 2 = 1.039 x [1.02/1.05] = 1.0093 SF/$, $ Value of Cash Flow = 4.2/1.0093 = $ 4.16 million

Year 3 = 1.0093 x [1.02/1.05] = 0.9802 SF/$, $ Value of Cash Flow = 4.2/0.9802 = $ 4.28 million

Year 4 = .9802 x [1.02/1.05] = 0.9522 SF/$, $ Value of Cash Flow = 4.2/0.9522 = $ 4.41 mllion

Year 5 = .9522 x [1.02/1.05] = 0.9249 SF/$, $ Value of Cash Flow = 4.2/0.9249 = $ 4.54 million

$ Discount Rate = 12 %

PV of $ Cash Flows = 4.04 / 1.12 + 4.16 / (1.12)^(2) + 4.28 / (1.12)^(3) + 4.41 / (1.12)^(4) + 4.54 / (1.12)^(5) = $ 15.35 million

Cost of Expansion = SF 16 million = 16 / 1.07 = $ 14.95 million

NPV = 15.35 - 14.95 = $ 0.4 million or $ 400000

(b) Current Exchange Rate = 1.07 SF / $ and Exchange Rate in Year 1 = 1.039 SF/$

A $ dollar required rate of return of 12 % implies that $ 100 invested into an asset for one year should return $ 112.

SF value of initial investment = 100 x 1.07 = SF 107

SF value of final investment proceeds = 112 x 1.039 = SF 116.368

SF Rate of Return = (116.368 - 107) / 107 = 0.08755 or 8.755 % approximately.

(c) Annual Cash Flows in SF = SF 4.2 million

PV of Annual SF Cash Flows = 4.2 x (1/0.08755) x [1-{1/(1.08755)^(5)}] = SF 16.44 million

NPV = 16.44 - 16 = SF 0.44 million or SF 440000

(d) $ NPV = $ 400000 and Current Exchange Rate = SF 1.07/$

SF NPV = 1.07 x 400000 = SF 428000

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