Lakonishok Equipment has an investment opportunity in Europe. The project costs
ID: 2743000 • Letter: L
Question
Lakonishok Equipment has an investment opportunity in Europe. The project costs €19 million and is expected to produce cash flows of €3.6 million in Year 1, €4.1 million in Year 2, and €5.1 million in Year 3. The current spot exchange rate is $1.09 / € and the current risk-free rate in the United States is 3.1 percent, compared to that in Europe of 2.9 percent. The appropriate discount rate for the project is estimated to be 10.5 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 €12.7 million.
What is the NPV of the project? (Do not round intermediate calculations and round your final answer to 2 decimal places. (e.g., 32.16). Enter your answer in dollars, not in millions. (e.g., 1,234,567.))
What is the NPV of the project? (Do not round intermediate calculations and round your final answer to 2 decimal places. (e.g., 32.16). Enter your answer in dollars, not in millions. (e.g., 1,234,567.))
Explanation / Answer
INTEREST RATE PARITY
= (1+Rh) / (1+ Rf) = F1/S0
F1 = S0 [(1+Rh) / (1+ Rf)]
FORWARD RATE AT YEAR1
= $1.09 [(1 + 0.031) / (1 + 0.029)]
= $1.0921
FORWARD RATE AT YEAR2
= $1.09 [(1 + 0.031) / (1 + 0.029)]2
= $1.0942
FORWARD RATE AT YEAR3
= $1.09 [(1 + 0.031) / (1 + 0.029)]3
= $1.0964
YEAR CASH FLOW IN ECRO CASH FLOW IN USD DISCOUNTING FACTOR DISCOUNTED CASHFLOW 0 (€19000000) ($20710000) 1.0000 ($20710000) 1 €3600000 $3931560 0.9050 $3558061.80 2 €4100000 $4486220 0.8190 $3674214.18 3 €5100000 $5591640 0.7412 $4144523.57 3 €12700000 $13924280 0.7412 $10320676.34 NPV $987475.89Related Questions
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