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 SF24 million. The cash flows from the project would be SF6.2 million per year for the next five years. The dollar required return is 10 percent per year, and the current exchange rate is SF1.05. The going rate on Eurodollars is 6 percent per year. It is 4 percent per year on Swiss francs.

a. Convert the projected franc flows into dollar flows and calculate the NPV. NPV $ =

b. What is the required return on franc flows? Return on franc flows % =

c. What is the NPV of the project in Swiss francs? NPV SF =

d. What is the NPV in dollars if you convert the franc NPV to dollars? NPV $ =

Explanation / Answer

a. Convert the projected franc flows into dollar flows and calculate the NPV. We can use relative purchasing power parity to calculate the dollar cash flows at each time E(S) SFr1.05(1+ (0.04-0.06))^t SFr 1.05(0.98)^t t SFr E(S) US$ Discount factor @ 9% 0 -24 1.0500 -22.8571 1.0000 -22.8571 1 6.2 1.0290 6.0253 0.9174 5.5278 2 6.2 1.0084 6.1482 0.8417 5.1748 3 6.2 0.9883 6.2737 0.7722 4.8445 4 6.2 0.9685 6.4017 0.7084 4.5352 5 6.2 0.9491 6.5324 0.6499 4.2456 1.4707 NPV of the project is $ 1.4707 million b. What is the required return on franc flows? Return on franc flows % = Rsfr = 1.10(1+(0.04-0.06))-1 0.078 7.80% c. What is the NPV of the project in Swiss francs? t SFr Discount factor @ 7.80% Present Value 0 -24 1.0000 -24.0000 1 6.2 0.9276 5.7514 2 6.2 0.8605 5.3352 3 6.2 0.7983 4.9492 4 6.2 0.7405 4.5911 5 6.2 0.6869 4.2589 0.8858 NPV of the project is $ 0.8858 million d. What is the NPV in dollars if you convert the franc NPV to dollars? NPV $ = 1 USD = SF 1.05 0.8858/1.05 0.84362 NPV of the project is $ 0.84362 million

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