**PLEASE SHOW FORMULAS FOR THE SOLUTIONS BELOW** The South Koreanmultinational m
ID: 2807371 • Letter: #
Question
**PLEASE SHOW FORMULAS FOR THE SOLUTIONS BELOW** The South Koreanmultinational manufacturing firm, Nam Sung Industries, is debating whether to invest in a 2-year project in the United States. The project's expected dollar cash flows consist of an initial investment of $1 million with cash inflows of $700,000 in Year 1 and $600,000 in Year 2. The risk-adjusted cost of capital for this project is 13%. The current exchange rate is 1,050 won per U.S. dollar. Risk-free interest rates in the United States and S. Korea are: 1-Year 2-Year United States 4% 4.25% S. Korea 3% 3.25%
a. If this project were instead undertaken by a similar U.S.-based company with the same risk-adjusted cost of capital, what would be the net present value generated by this project? Round your answer to the nearest cent $89,357 npv and rate of return 20%
B. What is the expected forward exchange rate 1 year and 2 years from now?1,039.90 won per us dollar and 1,029.95 won per us dollar
C. If Nam Sung undertakes the project, what is the net present value and rate of return of the project for Solitaire? 78,150,661 won NPV and rate of return on the projec 18.85%
Explanation / Answer
Solution:
a. If a U.S. based company undertakes the project, the rate of return for the project is a simple calculation, as is the net present value.
NPV = $1,000,000 + $700,000/1.13 + $600,000/(1.13)2 = $89,357.
Rate of return: Enter into your financial calculator or Excel cash flow register CF0 = 1,000,000, CF1 = 700,000, CF2 = 600,000 and calculate IRR = 20.0%
B. A direct quote from a Korean perspective is the number of won per dollar.
According to interest rate parity, the following condition holds:
Forward exchange rate/Spot exchange rate = ((1 + rkorea)/(1 + rUS))^t
For the 1-year forward rate:
Forward exchange rate/1050 = 1.03/1.04
Forward exchange rate/1050 = 0.990381
Forward exchange rate = 1,039.90 won per U.S. $.
The 2-year exchange rate is calculated as:
Forward exchange rate/1050 = (1.0325/1.0425)^2
2-year forward exchange rate = 1029.95 Won per U.S. dollar.
c. First, we must adjust the cash flows to reflect Nam Sung’s home currency.
The expected Won cash flows are
Year 0: (1,000,000 dollars)(1,050 won per dollar) = 1,050.00 million won.
Year 1: (700,000 dollars)(1039.90 won per dollar) = 727.93 million won.
Year 2: (600,000 dollars)(1029.95 won per dollar) = 617.97 million won.
Using the won-denominated cash flows, the appropriate NPV and rate of return can be found.
NPV = 1,050 + 727.93/1.13 + 617.97/1.132 = 78.15 million Won.
Rate of return: Enter into your financial calculator or Excel cash flow register CF0 = 1,050, CF1 = 727.93, CF2 = 617.97 and calculate IRR = 18.85%
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