Consider a US firm sells a gas turbine generator to a British firm; in March 201x for British pound BP 1,000,000. Payment is due
three months later in June 201x. The firm’s cost of capital is 12%. The following quotes are current in the market:1. spot rate: $1.764 per British pound2. 3-month forward rate: $1.754 per British pound3. 3-month interest rate for borrowing in U.K.: 2.5% Per quarter4. UK 3-month investment rate: 2.0% /quarter5. US 3-month borrowing rate: 2.0% /quarter6. US 3-month investment rate: 1.5% per quarter7. June put option in the over the counter market for British pound 1,000,000; strike price $1.71 (out-of-the money): 1% premium8. June put option on the Philadelphia Stock Exchange: a. British pound BP 31,250 per contract at strike price of $1.75 costb. 2.5 cents per pound premium, and brokerage cost $50 per contract9. the firm’s foreign exchange advisory service forecasts that the spot rate in three months will be $1.76 per pound.Show all your calculations of cost of the following alternatives:(i) Unhedged Position; (ii) Money Market Hedge; (iii) Forward market hedge; and (iv) Options Hedge;(Show your work. This means that No work is No credits)
1 answer:
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A) The company should not invest in the provided project due to the negative NPV of the project.
B) The NPV of the project comes out to be (286).
<h3>What is NPV?</h3>NPV is an abbreviated form of Net present value and computed by deducting the cash outflows from cash inflows at the present value.
Given values:
Cash flow of year 1: $10,000
Cash flow of year 2: $10,000
Cash flow of year 3: $2,000
Cash outflow (cost of investment) =$20,000
Step-1 Computation of PV of cash inflows of every year:
PV of year 1 = Cash inflow of year 1 / (1+ interest rate)^ 1
= $10,000 / (1+0.07) ^ 1
= $10,000 X 0.934579
= $9,346
PV of year 2 = Cash inflow of year 1 / (1+ interest rate)^ 2
= $10,000 / (1+0.07) ^ 2
= $10,000 X 0.873438
= $8,735
PV of year 3= Cash inflow of year 1 / (1+ interest rate)^ 3
= $2,000 / (1+0.07) ^ 2
= $2,000 X 0.816297
=$1,633
Step-2 Computation of total amount of PV of cash inflows:
Step-3 Computation of NPV:
Therefore, the NPV comes out to be a negative amount of 286, and hence, the company should not accept the project.
Learn more about the net present value in the related link:
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