You are CEO of Acme, Inc. located in the United States. You use the discounted p
ID: 2757019 • Letter: Y
Question
You are CEO of Acme, Inc. located in the United States. You use the discounted payback period method and accept all projects that payback in three years. You are considering a project that will cost $5,500,000 and will produce one cash flow that occurs in three years. However, the cash flow is in pesos since the project is an overseas project. The current indirect exchange rate is 13.5 pesos per dollar. The cash inflow in pesos is 100,000,000 in three years, and the discount rate is 11.5%. During this time, the anticipated annual inflation rate is 5% in the United States and 4% in Mexico.
A. Should you accept this project, using the discounted payback period method?
B. Is this a good decision? Provide the six (6) steps you would utilize to determine whether or not this is a good decision.
Explanation / Answer
Answer
The difference in inflation rate between USA and Mexico(5%-4%) is 1%. Therefore it is expected that the value of dollar will decline against Mexico by 1%, therefore it is expected that the PESO will be 13.5*1.01^3 = $13.91, therefore the 100 million pesos will be equal to 100/13.91 = $ 7.19 million.
The present value of 7.19 million at 11.5% discount rate will be 7.19/1.115^3 = $ 5.19 million which is less than $5.5 therefore the discounted payback period is not equal to three years or the net present value is $0.31 million negative therefore the project should not be undertaken
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