1. An MNC is considering establishing a two-year project in New Zealand with a $30 million initial investment. The firm's cost of capital is .12. The required rate of return on this project is 0.15. The project is expected to generate cash flows of NZ$10,900,000 in Year 1 and NZ$28,900,000 in Year 2, excluding the salvage value.
Assume no taxes, and a stable exchange rate of $0.51 per NZ$ over the next two years. All cash flows are remitted to the parent. What is the break-even salvage value?
2. Potter Company has a unique opportunity to invest in a two-year project in Australia. The project is expected to generate 1,100,000 Australian dollars (A$) in the first year and 2,200,000 Australian dollars in the second. Potter would have to invest $1,800,000 in the project. Potter has determined that the cost of capital for similar projects is 14%.
What is the net present value of this project if the spot rate of the Australian dollar for the two years is forecasted to be $.55 and $.60, respectively?
3. Castro Co. is considering the acquisition of a unit from the French government. Its initial outlay would be $3,600,000. It will reinvest all the earnings in the unit. It expects that at the end of 8 years, it will sell the unit for 13,200,000 euros after capital gains taxes are paid. The spot rate of the euro is $1.16 and is used as the forecast of the euro in the future years. Castro has no plans to hedge its exposure to exchange rate risk.
The annualized U.S. risk-free interest rate is .05 regardless of the maturity of the debt, and the annualized risk-free interest rate on euros is .07, regardless of the maturity of debt. Assume that interest rate parity exists. Castro's cost of capital is 0.16. It plans to use cash to make the acquisition. Determine the NPV under these conditions.
4. Dynasty Co. is considering the acquisition of a unit from the French government. Its initial outlay would be $5 million. It will reinvest all the earnings in the unit. It expects that at the end of 8 years, it will sell the unit for 14,000,000 euros after capital gains taxes are paid. The spot rate of the euro is $1.20 and is used as the forecast of the euro in the future years.
The annualized U.S. risk-free interest rate is 0.05 regardless of the maturity of the debt, and the annualized risk-free interest rate on euros is 0.08, regardless of the maturity of debt. Assume that interest rate parity exists. Dynasty's cost of capital is 20%.
Dynasty could partially finance the acquisition. It could obtain a loan of 3 million euros today that would be used to cover a portion of the acquisition.
In this case, it would have to pay back a lump sum total of 7 million euros at the end of 8 years to repay the loan. There are no interest payments on this debt.
The way in which this financing deal is structured, none of the payment is tax-deductible. Determine the NPV if Cantoon uses the forward rate instead of the spot rate to forecast the future spot rate of the euro, and elects to partially finance the acquisition.
[You need to derive the 8-year forward rate for this specific question.]