The South Korean multinational manufacturing firm, Nam Sung Industries, is debat

Question

The South Korean multinational manufacturing firm, Nam Sung Industries, is debating whether to invest in a 2-year project in the United States. The projects expected dollar cash flows consist of an initial investment of $1 million with cash inflows of $700,000 in Year 1 and $600,000 in Year 2. The risk-adjusted cost of capital for this project is 13%. The current exchange rate is 1,050 won per U.S dollar. Risk free interest rates in the United States and S. Korea are:

U.S. 1-year 4.0% 2-year 4.25%

S. Korea 1-year 3.0% 2-year 3.25%

a. If this project were instead undertaken by a similar U.S. based company with the same risk-adjusted cost of capital, what would be the net present value and rate of return generated by this project?

b. What is the expected forward exchange rate 1 year from now and 2 years from now? (hint: take the perspective of the Korean company when identifying home and foreign currencies and direct quotes of exchange rates.)

c. If Nam Sung undertakes the project, what is the net present value and rate of return of the project for Nam Sung?

Please show calculations so that I understand it. Thank you!

Explanation / Answer

a. Calculation of NPV

NPV = $700000x0.885 + $600000x0.783 - $1000000

= $89300

b. Calculation of 1 year forward exchange rate

$(1+0.04) = won1050(1+0.03)

$ = won1040

Calculation of 2 yea forward exchange rate

$(1.0425) = won1040(1.0325)

$ = 1030

c. Required rate of return in korean currency

= 1.13/1.04 x 1.03 = 1.1191

= 11.91%

NPV = $700000/1040 x 0.894 + $600000/1030 x0.798 - $1000000/1050

= 114.79

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