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Fundamentals of Financial Manageme...

14th Edition
Eugene F. Brigham + 1 other
ISBN: 9781285867977

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BuyFindarrow_forward

Fundamentals of Financial Manageme...

14th Edition
Eugene F. Brigham + 1 other
ISBN: 9781285867977
Textbook Problem

FOREIGN CAPITAL BUDGETING Solitaire Machinery is a Swiss multinational manufacturing company. Currently, Solitaire’s financial planners are considering undertaking a 1-year project in the United States. The project’s expected dollar-denominated cash flows consist of an initial investment of $1,000 and a cash inflow the following year of $1,200. Solitaire estimates that its risk-adjusted cost of capital is 12%. Currently, 1 U.S. dollar will buy 0 90 Swiss franc. In addition, 1-year risk-free securities in the United States are yielding 5%, while similar securities in Switzerland are yielding 3 25%.

  1. a. If this project was 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?
  2. b. What is the expected forward exchange rate 1 year from now?
  3. c. If Solitaire undertakes the project, what is the net present value and rate of return of the project for Solitaire?

a.

Summary Introduction

To determine: The net present value and rate of return, if the project is undertaken by Country U based company.

Exchange Rate:

It refers to exchange of one currency into another. For example, exchange of Country I’s rupee to Country U’s $, Euro to pound, Euro to Country U’s $.

Explanation

Given,

Cost of capital is 12% for both the countries.

Initial investment is $1,000.

Inflow after 1 year is $1,200.

Project life is 1 year.

Spot rate is 1US$=0.90SF.

Interest rate of US is 5%.

Interest rate of SF is 3.25%.

If project is undertaken in US:

NPV=PresentvalueofcashinflowsInitialinvestment=$1,071.42$1,000=$71

b.

Summary Introduction

To determine: The expected forward exchange rate.

c.

Summary Introduction

To determine: The Net present value and rate of return, if project is undertaken by Solitaire.

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