Consider the following information for the next 3 problems: Interest rate in the

Question

Consider the following information for the next 3 problems:          

Interest rate in the US            4%

Interest rate in Mexico 10%        

Mexican peso MXN/USD exchange rate        $0.1000

Euro EUR/USD exchange rate            $1.11

Swiss Franc CHF/USD exchange rate $1.26

20. You are a U.S. company and raise capital in the U.S. in dollars. You have an opportunity to make an investment that will cost 10 million pesos and will return 5 million pesos a year for 3 years. Your WACC is 10%. What is the NPV of your investment?

a.   $106,004

b.   $116,604

c.   $128,264

d.   $141,091

e.   $155,200 The answer is b. 116,604.

Explanation / Answer

Spot Rate = 0.1 USD per MXN

1 year forward rate = 0.10 (1+ Rate in US) / (1+Rate in Mexico) = 0.10 (1.04)/(1.1) =  0.0945

2 year forward rate = 0.10 (1+ Rate in US)2 / (1+Rate in Mexico)2 = 0.10 (1.04)2/(1.1)2 = 0.0894

3 year forward rate = 0.10 (1+ Rate in US)2 / (1+Rate in Mexico)2 = 0.10 (1.04)2/(1.1)2 = 0.0845

Caculation of NPV

Option b

Year CashFlows in MXN Exchange Rate CashFlows in USD Disc Factor @ 10%p.a. P/V in USD 0 -10,000,000.00             0.1000 -1,000,000.00 1.000 -1,000,000.00 1       5,000,000.00             0.0945        472,727.27 0.909        429,752.07 2       5,000,000.00             0.0894        446,942.15 0.826        369,373.68 3       5,000,000.00             0.0845        422,563.49 0.751        317,478.20 Net Present Value        116,603.94

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