Foreign Capital Budgeting The South Korean multinational manufacturing firm, Nam
ID: 2766540 • 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 10%. The current exchange rate is 1,060 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% 7.25% S. Korea 2% 6.25%Explanation / Answer
1) 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.
Answer: NPV = $132,231.40.
Calculations:
2) What would be the rate of return generated by this project? Round your answer to two decimal places.
IRR = 20.00%.
3) What is the expected forward exchange rate 1 year from now? Round your answer to two decimal places.
As per the IRPT the forward exchange rate for $ in terms of won is given by the formula
forward rate = spot rate *(1+Rh)/(1+Rf), where Rh is the interest rate in the home country and Rf the interest rate in the foreign country.
Therefore, 1 year forward rate = 1060*1.02/1.03 = 1049.71won per U.S. $
4) What is the expected forward exchange rate 2 year from now? Round your answer to two decimal places.
The forward rate = 1060*1.0625/1.0725 = 1050.12 won per U.S. $
5)
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.
calculations:
0 1 2 cash flows $ -1,000,000 700,000 600,000 pvif @ 10% 1.0000 0.9091 0.8264 pv -1000000.00 636363.64 495867.77 NPV 132231.40