Question

Ch 17: 7.

International capital budgeting One of the important components of multinational capital budgeting is to analyze the cash flows generated from subsidiary companies. Consider this case: Sacramone Products Co. is a U.S. firm evaluating a project in Australia. You have the following information about the project:

• The project requires an investment of AU$915,000 today and is expected to generate cash flows of AU$1,000,000 at the end of each of the next two years.

• The current exchange rate of the U.S. dollar against the Australian dollar is $0.7877 per Australian dollar (AU$).

• The one-year forward exchange rate is $0.8109 / AU$, and the two-year forward exchange rate is $0.8455 / AU$.

• The firm’s weighted average cost of capital (WACC) is 9%, and the project is of average risk.

What is the dollar-denominated net present value (NPV) of this project? (CHOOSE ONE) :

            A: $881,807

            B: $845,065

            C: $734,839

            D: $661,355

Answer 1

Initial Investment requirement in foreign subsidiary = AU$ 915,000

Project is expected to generate expected future cash flows at the end of next two years= AU$ 1000,000

Current Exchange rate = $0.7877 per Australian dollar (AU$)

Initial Investment in US $ = AU$ 915,000* $ 0.7877 per AU$

= $ 720,745.5

The one-year forward exchange rate = $0.8109 / AU$

Expected Future Cash flow at the end of 1 year in US $ = AU$ 1000,000 * $0.8109 per AU$

= $ 810900

The two-year forward exchange rate = $0.8455 / AU$

Expected Future Cash flow at the end of 2 year in US $ = AU$ 1000,000 * $0.8455 per AU$

= $ 845500

Firm's weighted average cost of capital (WACC) = 9%

Calculating the Dollar-dominated Net Present value (NPV) of this project:

Year	Cash flows in $	Present Value factor @ 9%	Present Value of Cash-flows in $
0	-720745.5	1	-720,745.5
1	810900	0.917431	743,944.95
2	845500	0.841680	711,640.43
		NPV	734,839.89

So, the dollar-denominated net present value (NPV) of this project is $ 734,839.89

Hence, Option C. $ 734,839

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