Foreign Capital Budgeting The South Korean multinational manufacturing firm, Nam

Question

Foreign Capital Budgeting

The South Korean multinational manufacturing firm, Nam Sung Industries, is debating whether to invest in a 2-year project in the United States. The project's expected dollar cash flows consist of an initial investment of $1 million with cash inflows of $700,000 in Year 1 and $600,000 in Year 2. The risk-adjusted cost of capital for this project is 11%. The current exchange rate is 1,069 won per U.S. dollar. Risk-free interest rates in the United States and S. Korea are:

If this project were instead undertaken by a similar U.S.-based company with the same risk-adjusted cost of capital, what would be the net present value generated by this project? Round your answer to the nearest cent.
$    

What would be the rate of return generated by this project? Round your answer to two decimal places.
    %

What is the expected forward exchange rate 1 year from now? Round your answer to two decimal places.
    won per U.S. $

What is the expected forward exchange rate 2 years from now? Round your answer to two decimal places.
    won per U.S. $

If Nam Sung undertakes the project, what is the net present value and rate of return of the project for Solitaire? Round your answers to two decimal places.

Explanation / Answer

if this project were instead undertaken by a similar U.S.-based company with the same risk-adjusted cost of capital,

net present value=NPV=-1000,000+ 700,000/1.111 + 600,000 /1.112

NPV=-1000,000+630630.63+ 486973.46

NPV=$ 117604.09

0=-1000,000+ 700,000/(1+r) + 600,000 /(1+r)2

7/(1+r) + 6 /(1+r)2-10=0

1/(1+r) = -7+/-sqrt(49+240)/12=-7+/-17/12=10/12=5/6=>1+r=6/5=1.20=>r=.20 or 20%

the rate of return generated by this project is 20.00%

expected forward exchange rate 1 year from now=1,069 won per U.S. dollar*(1.02/1.03)=1058.62 won per U.S. dollar

expected forward exchange rate 2 year from now=1,069 won per U.S. dollar*(1.0325/1.0425)2=1048.59 won per U.S. dollar (under PPP)

expected forward exchange rate 2 year from now=1,069 won per U.S. dollar*(1+ 2*.0325/1+ 2*.0425)=1049.30 won per U.S. dollar (under IRP) i think this is the apt value to take because PPP usually holds in a longer term.

If Nam Sung undertakes the project,

Investment in won= $1 million *1,069 won per U.S. dollar=1,069 million won

cash inflows of in Year 1=$.7 million *1058.62 won per U.S. dollar=741.034 million won

cash inflows of in Year 2=$.6 million *1049.30 won per U.S. dollar=629.58 million won

net present value=NPV=-1,069+ 741.034 /1.111 + 629.58 /1.112

NPV=-1,069+667.60+ 510.98

NPV= 109.58 millions won

0=-1,069+ 741.034 /(1+r) + 629.58 /(1+r)2

r=18.5% =>-1,069+ 741.034 /(1.185) + 629.58  /(1.185)2 =4

r=18.6% =>-1,069+ 741.034 /(1.186) + 629.58  /(1.186)2 =3.6

r=19% =>-1,069+ 741.034 /(1.19) + 629.58  /(1.19)2 =-1.7

r=18.8% =>-1,069+ 741.034 /(1.188) + 629.58  /(1.188)2 =.77

r=18.86% =>-1,069+ 741.034 /(1.1886) + 629.58  /(1.1886)2 =.085

Thus the rate of return generated by this project is 18.87%.

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