A U.S. company plans to lease a manufacturing facility in Canada for 2 years. Th

Question

A U.S. company plans to lease a manufacturing facility in Canada for 2 years. The company must spend 12.1 million Canadian dollars (CD) initially to refurbish the plant. The expected net cash flows from the plant for the next 2 years are: CF1 = 9.8 million CD and CF2 = 6.2 million CD. A similar project in the U.S. would have a cost of capital of 10%. In the U.S., a 1-year government bond pays 1.9% interest and a 2-year bond pays 2.5%. In Canada, a 1-year bond pays 2.1% and a 2-year bond pays 2.65%. The spot exchange rate is 1.0598 CD/US$. What is the NPV of the project?

Explanation / Answer

1 Year Fwd rate = 1.0598*(1+2.1%)/(1+1.9%) = 1.0619

2 Year Fwd rate = 1.0598*(1+2.65%)2/(1+2.5%)2 = 1.0629

Converting all the cashflows into USD

Investment = 12.1 / 1.0598 = 11.42 million USD

CF1 = 9.8 / 1.0619 = 9.23 million USD

CF2 = 6.2 / 1.0629 = 5.83 million USD

NPV = -11.42 + 9.23/(1+10%) +5.83/(1+10%)2

        = 1.79 Million USD

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