Question

You are evaluating a proposed expansion of an existing subsidiary located in Switzerland. The cost of the expansion would be SF 14 million. The cash flows from the project would be SF 4.0 million per year for the next five years. The dollar required return is 14 percent per year, and the current exchange rate is SF 1.05. The going rate on Eurodollars is 6 percent per year. It is 4 percent per year on Swiss francs.
a. Convert the projected franc flows into dollar flows and calculate the NPV.
b-1. What is the required return on franc flows?
b-2. What is the NPV of the project in Swiss francs?
b-3. What is the NPV in dollars if you convert the franc NPV to dollars?

Answer 1

Answer:

a-The net present value in dollars is 494939.0687.

b-1-The required return on franc flows is 11.72%.

b-2-The net present value in Francs is 519686.02.

b-3-The NPV in dollars as calculated from NPV in Francs is $494939.07

Explanation:

a

In order to find the solution, firstly the exchange rate for the 5 years is calculated. It is calculated using the formula:

$EER=CER*(1-GRD+GRF)^t$

Here

• EER is the expected exchange rate which is to be calculated
• CER is the current exchange rate which is 1.05
• GRD is the going rate of dollars which is 6% or 0.06
• GRF is the going rate of Francs which is 4% or 0.04
• t is the time in years.

From this exchange rate, the PV factor is calculated which is than used to find the present value and similarly net present value in total. The solution is provided in the attached Excel Sheet.

The net present value in dollars is 494939.07

b-1

The required rate on the Franc return is given as:

$FRR=(1+DR)(1-GRD+GRF)-1$

Here

• FRR is the franc return rate which is to be calculated
• DR is the dollar rate which is 14% or 0.14
• GRD is the going rate of dollar which is 6% or 0.06
• GRF is the going rate of Franc which is 4% or 0.04

So the value becomes:

$FRR=(1+DR)(1-GRD+GRF)-1\\FRR=(1+0.14)(1-0.06+0.04)-1\\FRR=0.1172\text{ or }11.72\%$

The required return on franc flows is 11.72%.

b-2

Similar to part a, the solution is found for the return rate of 11.72 and the exchange rate is not required. The values are as indicated in the excel sheet attached.

The net present value in Francs is 519686.02.

b-3

In order to convert the Franc NPV to dollars, the exchange rate of 1.05SF is used which gives

$NPV_{dollars}=\dfrac{NPV_{Francs}}{ER}$

Here

• NPV_dollars is the value of NPV which is to be calculated.
• NPV_francs is the value of NPV calculated in previous step which is 510686.02.
• ER is the exchange rate whose value is 1.05

So the equation becomes:

$NPV_{dollars}=\dfrac{NPV_{Francs}}{ER}\\NPV_{dollars}=\dfrac{519686.02}{1.05}\\NPV_{dollars}=494939.0666=\ 494939.07$

The NPV in dollars as calculated from NPV in Francs is $494939.07