Quantitative Problem: International Machinery Company (IMC) is a Swedish multina
ID: 2785791 • Letter: Q
Question
Quantitative Problem: International Machinery Company (IMC) is a Swedish multinational manufacturing company. Currently, IMC's financial planners are considering undertaking a 1-year project in the United States. The project's expected dollar-denominated cash flows consist of an initial investment of $2,750 and a cash inflow the following year of $3,950. IMC estimates that its risk-adjusted cost of capital is 12%. Currently, 1 U.S. dollar will buy 7.9 Swedish kronas. In addition, 1-year risk-free securities in the United States are yielding 6%, while similar securities in Sweden are yielding 5%.
a. If the interest parity holds, what is the forward exchange rate of Swedish krona per U.S. dollar? Round your answer to 2 decimal places. Do not round intermediate calculations. Answer is 7.82
B) If IMC undertakes the project, what is the net present value and rate of return of the project for IMC in home currency? Round your answer to 2 decimal places. Do not round intermediate calculations.
NPV: ????? Swedish kronas
Rate of return: ?????? %
Explanation / Answer
Forward rate
F = 7.9*1.05/1.06 = 7.825472 = 7.82 Swedish kronas / $
CF0 = -$2,750 = -2750*7.9 Swedish kronas
CF1 = $3,950 = 3950*7.82 Swedish kronas
In this problem, it is not mentioned whether 12% cost of capital is $ required return or Swedish kronas required return.
Assume it is $ required return. Then compute it in Swedish kronas required return
(1 + r)/1.12 = 1.05/1.06
r = 1.12*1.05/1.06 - 1 = 0.109434
NPV = -2750*7.9 + 3950*7.82/1.109434 = 6,117.12 Swedish kronas
If it is Swedish kronas required return,
NPV = -2750*7.9 + 3950*7.82/1.12 = 5,854.46 Swedish kronas
Now for IRR
2750*7.9 = 3950*7.82/(1 + r)
r = (3950*7.82)/(2750*7.9) - 1 = 0.4218 = 42.18%