Intel, a U.S. MNC, is contemplating making a foreign capital expenditure in Fran

Question

Intel, a U.S. MNC, is contemplating making a foreign capital expenditure in France. The initial cost of the project is €80,000,000. The annual cash flows over the three year economic life of the project in € are estimated to be €10,000,000 in year 1; €60,000,000 in year 2; and €75,000,000 in year 3. Intel’s cost of capital in U.S. dollars is 15% percent. Long-run inflation is forecasted to be 2.50 percent per annum in the U.S. and 1.0 percent for euro zone countries. The current spot foreign exchange rate is = $1.1098/€. Determine the present value for Intel‘s project in USD. Find this PV two ways. First, determine the present value for the project in USD by calculating the NPV in euros discounted at the euro equivalent cost of capital and then converting the NPV in euros to USD. ANSWER: euro equivalent cost of capital = __________ ANSWER: The present value in dollars = __________ Second, determine the present value for the project in dollars by converting all euro cash flows to dollars then calculating the PV in USD. ANSWER: The present value in dollars = __________

Explanation / Answer

Euro equivalent cost of capital = (1 + US cost) x (1 + euro inflation) / (1 + US inflation) - 1

= (1 + 15%) x (1 + 1%) / (1 + 2.5%) - 1 = 13.32%

NPV = CF0 + CF1 / (1 + r) + CF2 / (1 + r)^2 + .CF3 / (1 + r)^3

= - 80 + 10 / 1.1332 + 60 / 1.1332^2 + 75 / 1.1332^3

= $27,094,661

Forecast future exchange rates using inflation differential.

Exchange rate one-year later = Spot Rate x (1 + US rate) / (1 + euro rate) = 1.1098 x 1.025 / 1.01 = 1.1263$/€

and so on...

Forecast USD cash flows based on the exchange rate

CF ($) = CF (€) x $ / €

NPV = CF0 + CF1 / (1 + r) + CF2 / (1 + r)^2 + CF3 / (1 + r)^3

= -88.78 + 11.26 / 1.15 + 68.58 / 1.15^2 + 87 / 1.15^3

= $30,069,655

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