Lakonishok Equipment has an investment opportunity in Europe. The project cost E

Question

Lakonishok Equipment has an investment opportunity in Europe. The project cost E12 (Euros) million and is expected to produce cash flows of E2.7 million in year 1, E3.1 million in year 2, and E2.8 million in year 3. the current spot exchange rate is $1.3/E. The current risk-free rate in the United States is 5 percent, compared to that in Europe of 3.5 percent. The appropriate discount rate for the project is estimated to be 18 percent, the US cost of capital for the company. In addition, the subsidiary can be sold at the end of three years for an estimated E6.5 million. What is the NPV of a project? Please provide formula to confirm accuracy. Thank you.

Explanation / Answer

E(S1) = (1.05/1.035)1 ($1.3/) = $1.31884058/ E(S2)

= (1.05/1.035)2 ($1.3/) = $1.337954211/ E(S1) = (1.05/1.035)3 ($1.3/)

= $1.357344852/ Year 0 cash flow = -12,000,000 ($1.3/) = -$15,600,000

Year 1 cash flow = 2,700,000 ($1.31884058/) = $3,560,869.57

Year 2 cash flow = 3,000,000 ($1.337954211/) = $4,013,862.63

Year 3 cash flow = 2,800,000 + 6,500,000) ($1.357344852/) = $12,623,307.12

NPV = -$15,600,000 + ($3,560,869.57/1.18) + ($4,013,862.63/1.182) + ($12,623,307.12/1.183) = -$2,016,686

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