20. Lakonishok Equipment has an investment opportunity in Europe. The project co

Question

20. Lakonishok Equipment has an investment opportunity in Europe. The project costs €10 million and is expected to produce cash flows of €1.4 million in Year 1, €1.8 million in Year 2, and €2.9 million in Year 3. The current spot exchange rate is $1.29/€; and the current risk-free rate in the United States is 2.2 percent, compared to that in Europe of 1.4 percent. The appropriate discount rate for the project is estimated to be 14 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 €8.4 million. What is the NPV of the project? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16. Enter your answer in dollars, not in millions, e.g., 1,234,567.)

Explanation / Answer

Spot rate at the end of n year($/E)=Spot*((1+r_US)/(1+r_eur0))^n

Spot rate at the end of 1 year($/E)=1.29*(((1+0.022)/(1+0.014))^1)=$1.30/E

Spot rate at the end of 2 year($/E)=1.29*(((1+0.022)/(1+0.014))^2)=$1.31/E

Spot rate at the end of 3 year($/E)=1.29*(((1+0.022)/(1+0.014))^3)=$1.32/E

Initial Cash outflow in USD=10/1.29=$7.752M

Cash flow in year 1=1.4/1.30=$1.0769M

Cash flow in year2=1.8/1.31=$1.374M

Cash flow in year 3=2.9/1.32=$2.197M

Salvage Value=8.4/1.32=$6.364M

NPV=-7.752+1.0769/1.14+1.374/(1.14^2)+2.197/(1.14^3)+6.364/(1.14^3)

NPV=$0.028M

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