Question

A U.S.-based MNC has just established a subsidiary in Algeria. Shortly after the plant was built, the MNC determines that its exchange rate forecasts, which had previously indicated a slight appreciation in the Algerian dinar, were probably false. Instead of a slight appreciation, the MNC now expects that the dinar will depreciate substantially due to political turmoil in Algeria. This new development would likely cause the MNC to ____ its estimate of the previously computed net present value.

Answer 1

Answer:

A U.S.-based MNC has just established a subsidiary in Algeria. Shortly after the plant was built, the MNC determines that its exchange rate forecasts, which had previously indicated a slight appreciation in the Algerian dinar, were probably false. Instead of a slight appreciation, the MNC now expects that the dinar will depreciate substantially due to political turmoil in Algeria. This new development would likely cause the MNC to reduce its estimate of the previously computed net present value.

Explanation:

The difference between the present value of cash inflows and the present value of cash outflows over a period is referred to as the net present value (NPV).

NPV is used In capital budgeting and investment planning, NPV is used to analyze the profitability of a projected investment or project.

The company should therefore reduce the estimates because it will increase the discount rate which would, in turn, impact the net present value (NPV) and drag it down to lower value.

Answer 2

Answer:

This new development would likely cause the MNC to LOWER its estimate of the previously computed net present value.

Explanation:

All companies making foreign direct investments are face currency exchange risks. In this case, the Algerian dinar was expected to appreciate against the US dollar, which meant that nay calculations regarding the future cash flows could be carried out considering a strong dinar.

But now, due to internal turmoil the dinar is expected to depreciate heavily and that will reduce the future cash flows and negatively affect the NVP.

Imagine that a product has an initial investment of $1 million, and you needed 10 dinars to purchase $1. Then the future cash flows for the following 5 years were 3 million dinars per year, and the company required a 10% rate of return.

Since the company is based in the US it had to calculate the cash flows in US dollars, each cash flow = $300,000.

But if the dinar depreciates 15% against the US dollar, then each cash flow will equal $255,000.

We can use an excel spreadsheet and the NPV function to calculate the NPVs for both estimated and actual scenarios.

• The NPV before the depreciation = $137,236
• The NPV after the depreciation = -$33,349. The project is not feasible anymore due to the depreciation of the dinar.