Question

Quantitative Problem: International Machinery Company (IMC) is a Swedish multinational manufacturing company. Currently, IMC's financial planners are considering undertaking a 1-year project in the United States. The project's expected dollar-denominated cash flows consist of an initial investment of $2,000 and a cash inflow the following year of $3,850. IMC estimates that its risk-adjusted cost of capital is 20%. Currently, 1 U.S. dollar will buy 6.7 Swedish kronas. In addition, 1-year risk-free securities in the United States are yielding 6%, while similar securities in Sweden are yielding 5%. a. If the interest parity holds, what is the forward exchange rate of Swedish krona per U.S. dollar? Do not round intermediate calculations. Round your answer to two decimal places. Swedish krona per U.S. dollar b. If IMC undertakes the project, what is the net present value and rate of return of the project for IMC in home currency? Do not round intermediate calculations. Round your answers to two decimal places. NPV: Swedish kronas Rate of return:

Answer 1

a. Currently USD/SEK is 6.7

1y US Risk free rate is 6%

1y Sweden risk free rate is 5%

Therefore the 1y USD/SEK forward rate = 6.7 * e^(0.05-0.06)*1 = 6.6333 (since F = S0 * e^(Rfc-Rdc)*t) where S0 is the spot rate, Rfc is the RFR in foreign country, Rdc is RFR in domestic currency and t is the time

b. Currently outlay in SEK = 2000*6.7 = SEK 13400

Inflow at the end of 1 year = 3850 * 6.6333 = 25538.34 (If 1y forward USD receipts are hedged)

The NPV = -13400 + 25538.34/1.20 = SEK 7881.95 (since risk adjusted cost of capital is 20%)

The Rate of Return = ((25538.34/13400)-1)*100 = 90.58%