You are evaluating a proposed expansion of an existing subsidiary located in Swi
ID: 2753287 • Letter: Y
Question
You are evaluating a proposed expansion of an existing subsidiary located in Switzerland. The cost of the expansion would be SF 14 million. The cash flows from the project would be SF 4.0 million per year for the next five years. The dollar required return is 14 percent per year, and the current exchange rate is SF 1.05. The going rate on Eurodollars is 6 percent per year. It is 4 percent per year on Euroswiss. Use the approximate form of interest rate parity in calculating the expected spot rates.
Convert the projected franc flows into dollar flows and calculate the NPV. NPV $ __________
What is the required return on franc flows?
What is the NPV of the project in Swiss francs?
What is the NPV in dollars if you convert the franc NPV to dollars?
I know this question is on chegg already but I have tried calculating this so many times and have gotten wrong answers each time. I don't know what I'm doing wrong. Thank you!!!!
Explanation / Answer
Answer:
Spot Rate 1 US$= 1.05 SF Interest rate in Switzerland (SF) = 4% Interest rate in USA (US$) = 6% NPV to be calculated using foreign currency approach. The US investor has required rate of return from this project (in USA) = 14% Assumed that the risk premium for a risky project in USA and Switzerland is the same. (1+Required rate of return) = (1+risk free rate) (1+risk premium) USA (1+.14) = (1+ .06) (1+risk premium) 1+Risk premium = 1.14/1.06 Switezerland (1+Required rate of Return of project) = (1+risk free rate) (1+risk Premium) (1+Required rate of Return of project) = (1+.04) (1.14/1.06) 1.118490566 Required rate of return = 1.1185-1 .1185 or 11.85% Computation of PV of flows and NPV in US$ Year PVF @ 11.85% Inflows in SF Inflows in USD (1/1+r) (SF/1.05) P. Value 1 0.894054537 4000000 3,809,524 3,405,922 2 0.799333516 4000000 3,809,524 3,045,080 3 0.714647757 4000000 3,809,524 2,722,468 4 0.638934069 4000000 3,809,524 2,434,035 5 0.571241904 4000000 3,809,524 2,176,160 P. Value of Cash Inflow in US$ 13,783,664 Less: Outflow in US$ 13,333,333 NPV in US$ 450,331 Computation of PV of flows and NPV in SF Year PVF @ 11.85% Inflows in SF (1/1+r) P. Value 1 0.894054537 4000000 3,576,218 2 0.799333516 4000000 3,197,334 3 0.714647757 4000000 2,858,591 4 0.638934069 4000000 2,555,736 5 0.571241904 4000000 2,284,968 P. Value of Cash Inflow in SF 14,472,847 Less: Outflow in SF 14,000,000 NPV in SF 472,847 NPV in US$ if rate of Exchange is 1.05 SF per US$ = 472847.10/1.05 =450330.60Related Questions
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