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

Question

Lakonishok Equipment has an investment opportunity in Europe. The project costs 10 million and is expected to produce cash flows of 1.3 million in Year 1, 1.7 million in Year 2, and 2.8 million in Year 3. The current spot exchange rate is $1.28/ ; and the current risk-free rate in the United States is 2.1 percent, compared to that in Europe of 1.3 percent. The appropriate discount rate for the project is estimated to be 13 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 8.3 million. Use the exact form of interest rate parity in calculating the expected spot rates. What is the NPV of the project in U.S. dollars? (Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16. Enter your answer in dollars, not in millions, e.g., 1,234,567.) NPV

Explanation / Answer

E(S1) = (1.021/1.013)^1($1.28/€) =$1.29/€

E(S2) = (1.021/1.013)^2($1.28/€) =$1.3/€

E(S3) = (1.021/1.013)^3($1.28/€) =$1.31/€

Cash flow table is as follows

NPV is computed using =npv function of excel as =NPV(13%, CF from years 1-3)+ CF of year 0

Year Cash flows Rate Cash flows in USD 0 -10000000 $1.28 ($12,800,000.00) 1 1300000 $1.29 $1,677,141.16 2 1700000 $1.30 $2,210,504.91 3 11100000 $1.31 $14,547,281.36

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