Estimating the NPV Assume that a less developed country called LDC encourages direct foreign investment (DFI) in an effort to reduce its unemployment rate, currently at 15 percent. Also assume that several MNCs are likely to consider DFI in this country. The inflation rate in recent years has averaged 4 percent. The hourly wage in LDC for manufacturing work is the equivalent of approximately $5 per hour. When Piedmont Co. develops cash flow forecasts to perform a capital budgeting analysis for a project in LDC, it assumes a wage rate of $5 in year 1 and applies a 4 percent increase for each of the next 10 years. The components produced will be exported to Piedmont’s headquarters in the United States, to be used in the production of computers. Do you think Piedmont will overestimate or underestimate the net present value of this project? Why? (Assume that LDC’s currency is tied to the dollar and will remain that way.)

FindFind

International Financial Management

14th Edition
Madura
Publisher: Cengage
ISBN: 9780357130698
FindFind

International Financial Management

14th Edition
Madura
Publisher: Cengage
ISBN: 9780357130698

Solutions

Chapter 14, Problem 16QA
Textbook Problem

Estimating the NPV Assume that a less developed country called LDC encourages direct foreign investment (DFI) in an effort to reduce its unemployment rate, currently at 15 percent. Also assume that several MNCs are likely to consider DFI in this country. The inflation rate in recent years has averaged 4 percent. The hourly wage in LDC for manufacturing work is the equivalent of approximately $5 per hour. When Piedmont Co. develops cash flow forecasts to perform a capital budgeting analysis for a project in LDC, it assumes a wage rate of $5 in year 1 and applies a 4 percent increase for each of the next 10 years. The components produced will be exported to Piedmont’s headquarters in the United States, to be used in the production of computers. Do you think Piedmont will overestimate or underestimate the net present value of this project? Why? (Assume that LDC’s currency is tied to the dollar and will remain that way.)

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