Lakonishok Equipment has an investment opportunity in Europe. The project costs

Question

Lakonishok Equipment has an investment opportunity in Europe. The project costs €12 million and is expected to produce cash flows of €1.6 million in Year 1, €2 million in Year 2, and €3.1 million in Year 3. The current spot exchange rate is $1.31 / €; and the current risk-free rate in the United States is 2.4 percent, compared to that in Europe of 1.6 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 €8.6 million. What is the NPV of the project in U.S. dollars?

Explanation / Answer

US Discount rate 10% Year 0 1 2 3 Value in Euro -12 1.6 2 3.1 Salvage value in EURO 8.6 Cashflows -12 1.6 2 11.7 Exchange rate per euro 1.31 1.320315 1.330711 1.341189 Forward exchange rate is spot * (1 + us interest rate/ 1+ euro interest rate)^ period;SINCE US INTEREST RATE IS HIGHER ITS VALUE IS DEPRETIATING W.R.T.euro Value in USD -15.72 2.112504 2.661422 15.69191 Discounted cashflow in USD -15.72 1.920458 2.199523 11.78957 NPV IN USD 1,89,547.49 USD

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