Question

The South Korean multinational 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. won U.S. dollar. Risk-free interest rates in the United States and S. Korea are:

Country	1 - Year	2 - Year
U.S.	4.00%	4.25%
S. Korea	3.00%	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 and rate of return generated by this project?

b.What is the expected forward exchange rate 1 year from now and 2 years from now ( Hint: Take the perspective of the Korean Company when identifying home and foreign currencies and direct quotes of exchange rates.)

c.If Nam Sung undertakes the project, what is the net present value and rate of return of the project for Nam Sung?

Answer 1

Solution (1) NPV generated in the project is undertaken by US company with Sanne Riste Adsristed cost of capital Calculations year 1 year o Cashflows. |$1000000 PV factor @13% 1.000 $700000 0.885 year 2 $600.000 0.793 Pv 110,00,000 619500 | 469800 NPV = Present value of cash inflows — Presest value of cash outflows. - (6,19,500+4,69,800) – 10,00,000 = 10,89,300 -10,00,000 - $ 89.300 In tel ié NPV = $89300

.. 12 Rate of Returns Generated by the project Here we have to find IRR. IRR is the rate at which PV of cash install equals PV of cash out flows ice 10,00,000 = 70000 0 + 6,00,000 (1+e) (1+) ? By trial and error, at 20% =700000x.833 + 600000X.694 = 999,500 at 19% = 70,000 X .840 + 609000 X.706 = 10,11,600 Therefore IRR = lower rate + NPV at lower Rate x Dijos en. NPV at lower -NPV at - Rate Higher rate =19%+ 500 x1 10,11,600 –999500 19.0413%

Expected Forward Exchange rate Forward exchange rate - Spot ratex (i+ Rh) Cited Whege, Rhe Interest rate is home country R$ = Interest rate in foreign courstoy. Spot sate 1050 won /usd. ;; 1 year forward gate = 1050 X (1+3%) TH4 %) 1176 = 1039.904 won IUSD 2 year forward rate = 1050 X (1+3.25%) (1+4.251) 000,000 wid th =1039.928 won! $ i I year 2 year forward rate = 1039.904 won/ & forward rate = 1039.928 won' wa

© NPV for Namsung, NPV 2. Cashflous $ $1000,000 $700000 $600000 Exchange rate 1050 1039.90 1039.92 cash flows (wont 1050,000,000 727,930,000 6 23952006 PV at 13% 1 0.885 | 0.783 H050,000,00 o 1644,218050 488554416 NPV = 1132772466 -10 50,000,000 = 827 7 2466