Question

Global Electronics Inc. invested $1,000,000 to build a plant in a foreign country. The labor
and materials used in production are purchased locally. The plant expansion was estimated
to produce an internal rate of return of 20% in U.S. dollar terms. Due to a currency crisis,
the currency exchange rate between the local currency and the U.S. dollar doubled from
two local units per U.S. dollar to four local units per U.S. dollar.

Write a brief memo to the chief financial officer, Tom Greene, explaining the
impact the currency exchange rate change would have on the project’s internal rate of
return if (1) the plant produced and sold all product in the local economy only and
(2) the plant produced all product locally and exported all product to the United States
for sale.

Answer 1

From:- ABC

To:-The CFO, Global Electronics Inc.

Date:- 28-11-2019

Subject:- Impact of currency exchange rate on internal rate of return

1) By reviewing the impact of the currency exchange rate on the project's internal rate of return, it has been found that, there would be a significant change of currency exchange rate on the project's internal rate of return, based on the location where the products were actually sold. If the product is sold in the local market, then the internal rate of return will decrease as all the cash flows ( labor and material expenses, and sales) incurred in the local currency, because the net cash inflows in local market will be less.

2) If the plant produced all product locally and exported all product to the United States for sale then assets and liabilities will offset and there will be little exposure.