A project in South Korea requires an initial investment of 2 billion South Korea

Question

A project in South Korea requires an initial investment of 2 billion South Korean won. The project is expected to generate net cash flows to the subsidiary of 3 billion and 4 billion won in the 2 years of operation, respectively. The project has no salvage value. The current value of the won is 1,100 per U.S. dollar, and the value of the won is expected to remain constant over the next 2 years. What is the NPV of this project if the required rate of return is 13 percent? Now, repeat the question, except assume that the value of the won is expected to be 1,200 won per U.S. dollar after 2 yeras. Further assume that the funds are blocked and that the parent company will only be able to remit them back to the United States in 2 years. How does this affect the NPV of the project?

I need to know how to calculate the PV of parent cash flows for each year in Microsoft Excel or just the formula in general. And then how to calculate the NPV. Please provide examples based on the figures given above.

Explanation / Answer

76.Solution:

The payoff from the put option is $0 if the stock price rises and $25 if the stock price falls. From the binomial pricing model we can create a replicating portfolio with the following two equations:

$0 = ($32 × x) + (1.02 × y)

$25 = ($5 × x) + (1.02 × y)

x = –0.93 shares of stock

y = $29.05 of risk-free bonds

The value of the option is the value of the replicating portfolio:

(–0.93 × $29) + ($29.05) = $2.20

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