Question

You are analyzing a project with an initial cost of £130,000. The project is expected to return £20,000 the first year, £50,000 the second year, and £90,000 the third and final year. There is no salvage value. The current spot rate is £.8211. The nominal risk-free return is 5.0 percent in the U.K. and 6.5 percent in the U.S. The return relevant to the project is 15 percent in the U.S. Assume that uncovered interest rate parity exists. What is the net present value of this project in U.S. dollars?

Answer 1

Answer: Net Present Value = -$19,062

Explanation:

First, we'll compute the PV for the respective years

Present Value (Year-1)

= $0.6211 \times [1 + (0.055 - 0.06)]^{1}$

=0.6179945

Present Value (Year-2)

= $0.6211 \times [1 + (0.055 - 0.06)]^{2}$

=0.614904528

Present Value (Year-3)

= $0.6211 \times [1 + (0.055 - 0.06)]^{3}$

=0.611830005

Now, we'll compute the Cash Flow for the respective years

Cash Flow (Initial)

= $-130,000\times (\frac{1}{0.6211} )$

= -$209,306.07

Cash Flow (Year-1)

=$20,000\times (\frac{1}{0.61799} )$

=$32,362.75

Cash Flow (Year-2)

=$50,000\times (\frac{1}{0.61490} )$

=$81,313.44

Cash Flow (Year-3)

= $90,000\times (\frac{1}{0.611830} )$

=$147,099.68

Net Present Value:

= -$209,306.07 + ($32,362.75/1.141)+ ($81,313.44/1.142) +($147,099.68/1.143)

= -$209,306.07 +$28,388.38 + $62,568.05 + $99,288.10

= -$19,062