Love Co. (a SWISS firm) is planning to invest CHF 2.5 million in a project in De
ID: 2716766 • Letter: L
Question
Love Co. (a SWISS firm) is planning to invest CHF 2.5 million in a project in Denmark that will exist for one year. Its required rate of return on this project is 18%. It expects to receive cash flows of 2 million euros in one year from this project. The spot rate of the euro in one year is expected to be CHF 1.50. The one-year forward rate of the euro is presently CHF1.40. Love Co. wants to account also for the 20% probability of a crisis in Denmark. If this crisis occurs, Love would reduce its expected cash flows to 1 million euros in one year. Love Co. does not plan to hedge its expected cash flows. Show the distribution of possible outcomes for the project’s estimated NPV, including the probability of each possible outcome. Love Co. (a SWISS firm) is planning to invest CHF 2.5 million in a project in Denmark that will exist for one year. Its required rate of return on this project is 18%. It expects to receive cash flows of 2 million euros in one year from this project. The spot rate of the euro in one year is expected to be CHF 1.50. The one-year forward rate of the euro is presently CHF1.40. Love Co. wants to account also for the 20% probability of a crisis in Denmark. If this crisis occurs, Love would reduce its expected cash flows to 1 million euros in one year. Love Co. does not plan to hedge its expected cash flows. Show the distribution of possible outcomes for the project’s estimated NPV, including the probability of each possible outcome.Explanation / Answer
Answer:
The expected value of the cashflow in CHF = 1,800,000 Euro * CHF 1.5 = CHF2,700,000
The Present value of the expected cashflow = CHF2,700,000 /1.18 = CHF 2,288,135.6
NPV = PV of expected cashflow - Initial investment = CHF 2,288,135.6 - CHF2,500,000 = CHF -211,864.4
Possible Outcome Probability Cashflows (in Euro) Expected value Crisis 20% 1000000 200000 No Crisis 80% 2000000 1600000 Expected value = 1800000 EurosRelated Questions
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