5) Faulpeltz Gmbh. is a German subsidiary of Lazy Ltd., a British MNC. Faulpeltz
ID: 2798269 • Letter: 5
Question
5) Faulpeltz Gmbh. is a German subsidiary of Lazy Ltd., a British MNC. Faulpeltz is considering a 5-year project in Germany that requires an initial investment of 1,360 million Euros (EU). The project will generate cash flows of EU 450 million per year in the years 1 to 4 and EU 575 million at the end of year 5. The required rate of return for projects of similar risk in Germany is 10%, and in the U.K. is 12%. The annual inflation rate in Germany is expected to be 4.5% for the next several years. British (annual) inflation is expected to be 2.5%. The current spot exchange rate is 0.65 £/EU. Calculate the NPV in £-terms from the project's (Faulpeltz Gmbh.) point of view Calculate the NPV in £-terms from the parent's (Lazy Ltd.) point of view What is your recommendation to Lazy's managers in terms of whether they should accept or reject the project? Should Lazy's managers try to hedge the EU projected cash flows? Why/why not? a. b. d.Explanation / Answer
Answer:
NPV= -Co+C1/(1+r)^1+C2/(1+r)^2+......
a)
a)1 convert into pounds since it has been asked in the question with spot exchange rate of 0.65 pounds/ euro
a2.Increase the proejcted cashflow by 4.5% owing to increase in inflation in Germany...
a3. calculation of NPV by taking the projected cash flow minus the initial investment at the required rate of return of 10%
b1.Now convert them into pounds with spot exchange rate of 0.65 pounds/euro since we are talking about the parent company which is based out of london and in question it has been ask to be in pounds terms only
b2.Now increase the number by inflation rate of UK since we are talking about parent company
3. Now calculate NPV with required rate of return of 12% since we are taking into account of parent company which is initial cashflow/ (1+r)^1 ie.=299.81/(1+0.12)^1 ns so on for other cashflows as well
c) As per the lazy manager, they should accept the project since NPV is positive for the project due to better return vis-a-vis an inflation rate.
d)Lazy manager should hedge the EU project cashflows in euro since it gives much better forecasted NPV owing to better economic situation in Germany.
since in euro it gives higher NPV of 1226 and convert them into pounds which is 796.92 million pounds a compared to 244 million pounds. so it better to hedge in the euro and translate into dollars later on,
(ends)
Project cash flows 0 1 2 3 4 5 Million euro Intial investment 1360 Project cash flows 450 450 450 450 575Related Questions
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