Lakonishok Equipment has an investment opportunity in Europe. The project costs
ID: 2794930 • Letter: L
Question
Lakonishok Equipment has an investment opportunity in Europe. The project costs €12 million and is expected to produce cash flows of €2.1 million in Year 1, €2.5 million in Year 2, and €3.6 million in Year 3. The current spot exchange rate is $1.36 / €; and the current risk-free rate in the United States is 2.9 percent, compared to that in Europe of 2.1 percent. The appropriate discount rate for the project is estimated to be 15 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 €9.1 million. Use the exact form of interest rate parity in calculating the expected spot rates.
What is the NPV of the project in U.S. dollars? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)
Explanation / Answer
Forward rate= USD per euro * (1+Interest rate in US)/(1+Interest rate in Europe) US Europe Spot rate 2.90% 2.10% Year Forward rate per euro Forward rate per euro 1 =1.36*(1+2.90%)/(1+2.10%) 1.3707 2 =1.3707*(1+2.90%)/(1+2.10%) 1.3814 3 =1.3814*(1+2.90%)/(1+2.10%) 1.3922 Cash flow Year Cash flow in EURO Cash flow in USD Cash flow in USD PV factor @ 15% Present Value 0 (12.00) =-12*1.36 (16.32) 1.0000 (16.32) 1 2.10 =2.1*1.3707 2.88 0.8696 2.50 2 2.50 =2.5*1.3814 3.45 0.7561 2.61 3 3.60 =3.6*1.3922 5.01 0.6575 3.30 3 9.10 =9.1*1.3922 12.67 0.6575 8.33 Total Present Value 0.42 in millions
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