Etihad Amalgamated, a U.S. manufacturing firm, is considering a new project in P

Question

Etihad Amalgamated, a U.S. manufacturing firm, is considering a new project in Portugal. You are in Etihad's corporate finance department and are responsible for deciding whether to undertake the project. The expected free cash flows, in euros, are shown here: You know that the spot exchange rate is $0.75/epsilon. In addition, the risk-free interest rate on dollars is 4.3% and the risk-free interest rate on euros is 5.6%. Assume that these markets are internationally integrated and the uncertainty in the free cash flows is not correlated with uncertainty in the exchange rate. You determine that the dollar WACC for these cash flows is 8.1%. What is the dollar present value of the project? Should Etemadi Amalgamated undertake the project? (Enter all outflows of cash as negative numbers.)

Explanation / Answer

INTEREST RATE PARITY

FORWARD RATE / CURRENT RATE = [(1 + Rf) / (1 + Rh)]n

FORWARD RATE FOR YEAR1

= $0.75 [(1 + 0.056) / (1 + 0.043)]1

= $0.75 * 1.056 / 1.043

= $0.7593

FORWARD RATE FOR YEAR 2

= $0.75 [(1 + 0.056) / (1 + 0.043)]2

= $0.75 * (1.056 / 1.043)2

= $0.75 * 1.01252

= $0.75 * 1.025

= $0.7688

FORWARD RATE FOR YEAR 3

= $0.75 [(1 + 0.056) / (1 + 0.043)]3

= $0.75 * (1.056 / 1.043)3

= $0.75 * 1.01253

= $0.75 * 1.0380

= $0.7785

FORWARD RATE FOR YEAR 4

= $0.75 [(1 + 0.056) / (1 + 0.043)]4

= $0.75 * (1.056 / 1.043)4

= $0.75 * 1.01254

= $0.75 * 1.0509

= $0.7882

YES ETEMADI SHOULD UNDERTAKE THE PROJECT AS IT HAS A POSITIVE NPV.

YEAR EURO CASH FLOW EXCHANGE $ CASH FLOW DISCOUNTING FACTOR DISCOUNTED CASH FLOW 0 -15.3 0.75 -11.475 1.0000 -11.475 1 8.6 0.7593 6.530 0.9251 6.041 2 9.8 0.7688 7.534 0.8557 6.447 3 11.3 0.7785 8.797 0.7916 6.964 4 11.7 0.7882 9.222 0.7323 6.753 NPV 14.73

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