Problem 31-14 Capital Budgeting Lakonishok Equipment has an investment opportuni

Question

Problem 31-14 Capital Budgeting

Lakonishok Equipment has an investment opportunity in Europe. The project costs €19 million and is expected to produce cash flows of €3.6 million in Year 1, €4.1 million in Year 2, and €5.1 million in Year 3. The current spot exchange rate is $1.09 / € and the current risk-free rate in the United States is 3.1 percent, compared to that in Europe of 2.9 percent. The appropriate discount rate for the project is estimated to be 10.5 percent, the U.S. cost of capital for the company. In addition, the subsidiary can be sold at the end of three years for an estimated €12.7 million.

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

Lakonishok Equipment has an investment opportunity in Europe. The project costs €19 million and is expected to produce cash flows of €3.6 million in Year 1, €4.1 million in Year 2, and €5.1 million in Year 3. The current spot exchange rate is $1.09 / € and the current risk-free rate in the United States is 3.1 percent, compared to that in Europe of 2.9 percent. The appropriate discount rate for the project is estimated to be 10.5 percent, the U.S. cost of capital for the company. In addition, the subsidiary can be sold at the end of three years for an estimated €12.7 million.

Explanation / Answer

$/€ Cash flow E(S0) 1.09 -19000000 -20710000 E(S1) = (1.031/1.029)^1 ($1.09/€) 1.092119 3600000 3931627 E(S2) = (1.031/1.029)^2 ($1.09/€) 1.096368 4100000 4495109 E(S3) = (1.031/1.029)^3 ($1.09/€) 1.102773 17800000 19629365 Year 0 1 2 3 Initial Investment -20710000 3931627 4495109 19629365 Discount Factor 1 0.904977 0.8189841 0.741162036 -20710000 3558033 3681422.6 14548539.9 NPV 1077995.79

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