Lakonishok Equipment has an investment opportunity in Europe. The project costs
ID: 2653889 • Letter: L
Question
Lakonishok Equipment has an investment opportunity in Europe. The project costs €10 million and is expected to produce cash flows of €1.0 million in Year 1, €1.4 million in Year 2, and €2.5 million in Year 3. The current spot exchange rate is $1.25/€; the current risk-free rate in the United States is 1.8 percent, compared to that in Europe of 1.0 percent. The appropriate discount rate for the project is estimated to be 10 percent, the U.S. cost of capital for the company. In addition, the subsidiary can be sold at the end of three years for an estimated €8.0 million. Use the exact form of interest rate parity in calculating the expected spot rates.
What is the NPV of the project? (Enter your answer in thousands of dollars, not in millions. (e.g., 1,234,567). Do not round intermediate calculations and round your final answer to 2 decimal places. (e.g., 32.16))
Lakonishok Equipment has an investment opportunity in Europe. The project costs €10 million and is expected to produce cash flows of €1.0 million in Year 1, €1.4 million in Year 2, and €2.5 million in Year 3. The current spot exchange rate is $1.25/€; the current risk-free rate in the United States is 1.8 percent, compared to that in Europe of 1.0 percent. The appropriate discount rate for the project is estimated to be 10 percent, the U.S. cost of capital for the company. In addition, the subsidiary can be sold at the end of three years for an estimated €8.0 million. Use the exact form of interest rate parity in calculating the expected spot rates.
Explanation / Answer
Answer:
Calculation of NPV
(Figures in 000's)
Year 0
Year 1
Year 2
Year 3
Initial investment in €
€ (10,000)
Cash Flows in €
€ 1,000
€ 1,400
€ 2,500
Sale value of Subsidiary in €
€ 8,000
Net cash Flows in €
€ (10,000)
€ 1,000
€ 1,400
€ 10,500
Exchange rate
$1.2500
$1.2402
$1.2304
$1.2208
Given
($1.25 *1.01 /1.018)
(1.25*(1.01)^2/(1.018)^2)
(1.25*(1.01)^3/(1.018)^3)
Cash Flows in $
$ (12,500.00)
$ 1,240.18
$ 1,722.60
$ 12,818.00
PVF (10%)
1.00000
0.90909
0.82645
0.75131
PV = Cash Flows * PVF
$ (12,500.00)
$ 1,127.43
$ 1,423.64
$ 9,630.35
Net Present value = Sum of PVs
$ (318.58)
Calculation of NPV
(Figures in 000's)
Year 0
Year 1
Year 2
Year 3
Initial investment in €
€ (10,000)
Cash Flows in €
€ 1,000
€ 1,400
€ 2,500
Sale value of Subsidiary in €
€ 8,000
Net cash Flows in €
€ (10,000)
€ 1,000
€ 1,400
€ 10,500
Exchange rate
$1.2500
$1.2402
$1.2304
$1.2208
Given
($1.25 *1.01 /1.018)
(1.25*(1.01)^2/(1.018)^2)
(1.25*(1.01)^3/(1.018)^3)
Cash Flows in $
$ (12,500.00)
$ 1,240.18
$ 1,722.60
$ 12,818.00
PVF (10%)
1.00000
0.90909
0.82645
0.75131
PV = Cash Flows * PVF
$ (12,500.00)
$ 1,127.43
$ 1,423.64
$ 9,630.35
Net Present value = Sum of PVs
$ (318.58)
Related Questions
Navigate
Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.