Problem 20-14 Capital Budgeting Lakonishok Equipment has an investment opportuni

Question

Problem 20-14 Capital Budgeting

Lakonishok Equipment has an investment opportunity in Europe. The project costs €15,300,000 and is expected to produce cash flows of €3,900,000 in Year 1, €4,900,000 in Year 2, and €5,300,000 in Year 3. The current spot exchange rate is $.77 / €; and the current risk-free rate in the United States is 2.3 percent, compared to that in euroland of 2.7 percent. The appropriate discount rate for the project is estimated to be 13 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 €9,800,000.

What is the NPV of the project in U.S. dollars? (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).) NPV $

Explanation / Answer

Approach 1 : Host Currency or Foreign Currency Approach

Step 1: Establish host currency cash flows:

USA is the home country and Europe is the host country. The cash flows are already in Euros.

Step 2: Identify host currency discount rate:

WN 1: The Exchange rate is $ 77/Euro. For the American this is a direct quote. In that context Euro is the commodity. Using (F-S)/S, the future spot rates are arrived at.

Step 3: Discount Euro cash flows at Euro discount rate :

Step 4: Convert at spot rate to arrive at home currency NPV: 24,54,110 @ 77 $/Euro = $ 18,89,66,470

The NPV is positive and the project should be accepted.

Related Questions

Navigate

• Browse (All)
• Browse P
• Subjects

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.