Question

You are evaluating a proposed expansion of an existing subsidiary located in Switzerland. The cost of the expansion would be SF 21 million. The cash flows from the project would be SF 5.9 million per year for the next five years. The dollar required return is 14 percent per year, and the current exchange rate is SF 1.11. The going rate on Eurodollars is 4 percent per year. It is 2 percent per year on Euroswiss. Use the approximate form of interest rate parity in calculating the expected spot rates. a. Convert the projected franc flows into dollar flows and calculate the NPV. (Do not round intermediate calculations and enter your answer in dollars, not in millions, rounded to two decimal places, e.g., 1,234,567.89) b-1. What is the required return on franc flows? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.) b-2. What is the NPV of the project in Swiss francs? (Do not round intermediate calculations and enter your answer in francs, not in millions, rounded to two decimal places, e.g., 1,234,567.89) b-3. What is the NPV in dollars if you convert the franc NPV to dollars? (Do not round intermediate calculations and enter your answer in dollars, not in millions, rounded to two decimal places, e.g., 1,234,567.89) a. NPV b-1. Return on franc flows b-2. NPV b-3. NPV SF

Answer 1

a. Calculate the NPV after converting the franc flows into dollar flows: Year Present Exchange rate value factor Cash flow (note 1) Cash flow (S) @ 14% Present value 0-21000000 1.1100 -1,89,18.919 1.00000 -1,89,18,918.92 1 5900000 1.0878 54,23,791 0.87719 47,57.711.52 2 59000001 1 .0660 55.34.481 0.7694742.58.603.23 3 5900000 1.0447 56,47,429 0.67497 38,11,853.94 4 5900000 1.0238 57.62.683 0.59208 34.11.970.95 5900000 1.0034 58,80.289 0.51937 30,54,037.73 Net present value 3,75,258.45 5 Hence, the net present value is $375,258.45. Calculations: 1 Year Cash flow Exchange rate (note 1) Cash flow (S) Present value factor @ 14% 20 -21000000 1.11 =+B2/C2 31 5900000 1.0878 =+B3/C3 =1/1.14 4 2 5900000 1.066044 =+B4/C4 =1/(1.14912 5 3 5900000 1.04472312 =+B5/C5 =1/(1.14) 3 6 4 5900000 1.0238286576 =+B6/C6 =1/(1.1494 7 5 5900000 1.003352084448 +B7/07 =1/(1.14) 5 Net present value Present value =+D2 E2 =+D3 E3 =+D4E4 =+DS ES =+D6 E6 +D7%E7 SUM(F2:F7) 8

Note1 - Calculation of exchange rate: Year 0 (1-dollar rate + swiss Exchange rate Rate (A) rate)(B) (AXB) 1.11 1.11 0.98 1.0878 1.11 0.98 1.0660 1.111 0.981 1.0447 1.11 0.98 1.0238 1.11 0.98 1.0034 S/ B1. Calculate the required return on franc flows: Return on franc flows = 1.14X (1+0.02-0.04) - 1 = 1.14x 0.98 - 1 = 1.1172 - 1 = 11.72%. B2. Calculate the NPV of the project in swiss francs:

Present value factor Year Cash flow @11.72% Present value 0 -21000000 1.00000-2.10,00,000.00 1 5900000 0.89509 52.81.059.79 2 5900000 0.80119 47.27.049.58 3 5900000 0.71715 42,31,157.88 45900000 0.64191 37.87.287.75 5 5900000 0.57457 33,89,981.88 Net present value 4,16,536.88 Hence, the net present value is SF 416,536.88. Calculations: Art D 12 Year 13 0 14 1 15 2 16 3 17 4 18 5 Present value factor Cash flow @ 11.72% -21000000 5900000 =1/(1.1172) 5900000 =1/(1.1172)^2 5900000 =1/(1.1172)3 5900000 1=1/(1.1172) 4 5900000 1=1/(1.1172)5 Net present value Present value =+B13 C13 =+B14°C14 =+B15*C15 =+B16°C16 =+B17°C17 =+B18"C18 -SUM(D13:D18)

B3. Calculate the NPV in dollars if you convert the franc NPV to dollars: NPV in franc NPV in dollar = Exchange rate 416,536.88 1.11 = $375,258.45