Foreign Capital Budgeting The South Korean multinational manufacturing firm, Nam
ID: 2714182 • Letter: F
Question
Foreign Capital Budgeting
The South Korean multinational manufacturing firm, Nam Sung Industries, is debating whether to invest in a 2-year project in the United States. The project's expected dollar cash flows consist of an initial investment of $1 million with cash inflows of $700,000 in Year 1 and $600,000 in Year 2. The risk-adjusted cost of capital for this project is 11%. The current exchange rate is 1,069 won per U.S. dollar. Risk-free interest rates in the United States and S. Korea are:
If this project were instead undertaken by a similar U.S.-based company with the same risk-adjusted cost of capital, what would be the net present value generated by this project? Round your answer to the nearest cent.
$
What would be the rate of return generated by this project? Round your answer to two decimal places.
%
What is the expected forward exchange rate 1 year from now? Round your answer to two decimal places.
won per U.S. $
What is the expected forward exchange rate 2 years from now? Round your answer to two decimal places.
won per U.S. $
If Nam Sung undertakes the project, what is the net present value and rate of return of the project for Solitaire? Round your answers to two decimal places.
1-Year 2-Year United States 3% 4.25% S. Korea 2% 3.25%Explanation / Answer
if this project were instead undertaken by a similar U.S.-based company with the same risk-adjusted cost of capital,
net present value=NPV=-1000,000+ 700,000/1.111 + 600,000 /1.112
NPV=-1000,000+630630.63+ 486973.46
NPV=$ 117604.09
0=-1000,000+ 700,000/(1+r) + 600,000 /(1+r)2
7/(1+r) + 6 /(1+r)2-10=0
1/(1+r) = -7+/-sqrt(49+240)/12=-7+/-17/12=10/12=5/6=>1+r=6/5=1.20=>r=.20 or 20%
the rate of return generated by this project is 20.00%
expected forward exchange rate 1 year from now=1,069 won per U.S. dollar*(1.02/1.03)=1058.62 won per U.S. dollar
expected forward exchange rate 2 year from now=1,069 won per U.S. dollar*(1.0325/1.0425)2=1048.59 won per U.S. dollar (under PPP)
expected forward exchange rate 2 year from now=1,069 won per U.S. dollar*(1+ 2*.0325/1+ 2*.0425)=1049.30 won per U.S. dollar (under IRP) i think this is the apt value to take because PPP usually holds in a longer term.
If Nam Sung undertakes the project,
Investment in won= $1 million *1,069 won per U.S. dollar=1,069 million won
cash inflows of in Year 1=$.7 million *1058.62 won per U.S. dollar=741.034 million won
cash inflows of in Year 2=$.6 million *1049.30 won per U.S. dollar=629.58 million won
net present value=NPV=-1,069+ 741.034 /1.111 + 629.58 /1.112
NPV=-1,069+667.60+ 510.98
NPV= 109.58 millions won
0=-1,069+ 741.034 /(1+r) + 629.58 /(1+r)2
r=18.5% =>-1,069+ 741.034 /(1.185) + 629.58 /(1.185)2 =4
r=18.6% =>-1,069+ 741.034 /(1.186) + 629.58 /(1.186)2 =3.6
r=19% =>-1,069+ 741.034 /(1.19) + 629.58 /(1.19)2 =-1.7
r=18.8% =>-1,069+ 741.034 /(1.188) + 629.58 /(1.188)2 =.77
r=18.86% =>-1,069+ 741.034 /(1.1886) + 629.58 /(1.1886)2 =.085
Thus the rate of return generated by this project is 18.87%.