1.You are a U.S. investor who is trying to calculate the present value of a €5 million cash inflow that will occur one year in the future. The spot exchange rate is S = $1.25/€ and the forward rate is F1 = $1.215/€. You estimate that the appropriate dollar discount rate for this cash flow is 4% and the appropriate euro discount rate is 7%.
a. What is the present value of the €5 million cash inflow computed by first discounting the euro and then converting it into dollars?
b. What is the present value of the €5 million cash inflow computed by first converting the cash flow into dollars and then discounting?
c. What can you conclude about whether these markets are internationally integrated, based on your answers to parts (a) and (b)?
2.Mia Caruso Enterprises, a U.S. manufacturer of children’s toys, has made a sale in Cyprus and is expecting a C£4 million cash inflow in one year. (The currency of Cyprus is the Cypriot pound, C£. Cyprus is a member of the European Union, but has not yet adopted the euro.) The current spot rate is S = $1.80/C£ and the one-year forward rate is F1 = $1.8857/C£.
a. What is the present value of Mia Caruso’s C£4 million inflow computed by first discounting the cash flow at the appropriate Cypriot pound discount rate of 5%, and then converting the result into dollars?
b. What is the present value of Mia Caruso’s C£4 million inflow computed by first converting the cash flow into dollars, and then discounting at the appropriate dollar discount rate of 10%?
c. What can you conclude about whether these markets are internationally integrated, based on your answers to parts (a) and (b)?
3.Etemadi Amalgamated, a U.S. manufacturing firm, is considering a new project in the euro area. You are in Etemadi’s corporate finance department and are responsible for deciding whether to undertake the project. The expected free cash flows, in euros, are shown here:
You know that the spot exchange rate is S = $1.15/€. In addition, the risk-free interest rate on dollars is 4% and the risk-free interest rate on euros is 6%.
Assume that these markets are internationally integrated and the uncertainty in the free cash flows is not correlated with uncertainty in the exchange rate.You determine that the dollar WACC for these cash flows is 8.5%. What is the dollar present value of the project? Should Etemadi Amalgamated undertake the project?
4.Etemadi Amalgamated, the U.S. manufacturing company in Problem 3, is still considering a new project in the euro area. All information presented in Problem 3 is still accurate, except the spot rate is now S = $0.85/€, about 26% lower. What is the new present value of the project in dollars? Should Etemadi Amalgamated undertake the project?
5.You work for a U.S. firm, and your boss has asked you to estimate the cost of capital for countries using the euro. You know that S = $1.20/€ and F1 = $1.157/€. Suppose the dollar WACC for your company is known to be 8%. If these markets are internationally integrated, estimate the euro cost of capital for a project with free cash flows that are uncorrelated with spot exchange rates. Assume the firm pays the same tax rate no matter where the cash flows are earned.
6.Maryland Light, a U.S. light fixtures manufacturer, is considering an investment in Japan. The dollar cost of equity for Maryland Light is 11%. You are in the corporate treasury department, and you need to know the comparable cost of equity in Japanese yen for a project with free cash flows that are uncorrelated with spot exchange rates. The risk-free interest rates on dollars and yen are r$ = 5% and r¥ = 1%, respectively. Maryland Light is willing to assume that capital markets are internationally integrated. What is the yen cost of equity?