Nicorex Inc., a US corporation, expects to receive cash dividends from an Italia

Question

Nicorex Inc., a US corporation, expects to receive cash dividends from an Italian joint venture over the next four years. Suppose that today is January 1st, 2016. The first dividend, to be paid on December 31, 2016, is expected to be €1,000,000. The dividend is then expected to grow 10.0% each year over the following three years.

The current exchange rate (that is, as of January 1st, 2016) is $1.1079/€. Nicorex’s weighted average cost of capital for domestic investments is 12%. For foreign investments, Nicorex’s practice is to add an additional risk premium of 3%.

Suppose that the expected annual inflation is 2% in the US and 0.5% in the eurozone. Assume that the euro-dollar exchange rate movement will be in accordance with relative purchasing power parity.

Compute the present value in dollars of the expected stream of euro dividends. (30 points)

Explanation / Answer

Forward Exchange Rate(PPP) = Spot Rate*(1+Inflation US)^n/(1+Inflation Euro)^n

Year Dividend Exchange Rate $ Value PVF@15% $ Value*PVF 2016 €   1,000,000 1.1244 $1,124,400.00 0.8696 $977,739.13 2017 €   1,100,000 1.1412 $1,255,320.00 0.7561 $949,202.27 2018 €   1,210,000 1.1583 $1,401,543.00 0.6575 $921,537.27 2019 €   1,331,000 1.1455 $1,524,660.50 0.5718 $871,729.59 Present Value $3,720,208.26

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