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Fundamentals of Financial Manageme...

15th Edition
Eugene F. Brigham + 1 other
ISBN: 9781337395250

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BuyFindarrow_forward

Fundamentals of Financial Manageme...

15th Edition
Eugene F. Brigham + 1 other
ISBN: 9781337395250
Textbook Problem

FOREIGN CAPITAL BUDGETING Sandrine Machinery is a Swiss multinational manufacturing company. Currently, Sandrine’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 52,000 and a cash inflow the following year of $2,400. Sandrine estimates that its risk-adjusted cost of capital is 10%. Currently, 1 U.S. dollar will buy 0.96 Swiss franc. In addition, 1-year risk-free securities in the United States are yielding 3%, while similar securities in Switzerland are yielding 1.50%.

  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 Sandrine undertakes the project, what is the net present value and rate of return of the project for Sandrine?

a)

Summary Introduction

To determine: The net present value and rate of return from the given project under Country U based company.

Introduction:

Multinational Company refers to such company, which operates its activities in the home country and in one or more foreign countries. The head office is always situated in the home country of the company.

Net Present Value (NPV) is that amount, which indicates the difference reported on the cash outflows from the cash inflows.

The rate of return refers to that rate, which indicates the proportion of amount, which an investor gets as income annually from an investment.

Explanation

Given information:

The initial investment (cash outflow) is $2,000.

The cash inflow is $2,400.

The risk-adjusted cost of capital is 10% or 0.10.

The exchange rate of 1 Country U dollar is 0.96 Country S francs.

The period of the project is 1 year.

The formula to calculate net present value:

NPV=Present value of cash inflowPresent value of cash outflow

The formula to calculate the rate of return:

Rate of return=(Cash inflowCash outflow1)×100

The formula to calculate the present value of cash flow:

Present value of cash inflow=Cash inflow(1+r)n

Where,

n is number of years

r is risk adjusted cost of capital

Compute present value of cash flow:

Present value of cash inflow=Cash inflow(1+r)n=$2,400(1+0

b)

Summary Introduction

To determine: The expected forward exchange rate for 1 year.

Introduction:

The rate at which the bank exchanges one country’s currency with another country currency at a future date is termed as forward exchange rate. This happens when it enters into a contract of forward contract.

c)

Summary Introduction

To determine: The net present value and rate of return from the given project under S company.

Introduction:

Net Present Value (NPV) the amount which indicates the difference reported on the cash outflows from the cash inflows.

The rate of return refers to the rate, which indicates the proportion of amount the investor gets as income annually from an investment.

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