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(Solved): the answer in the box is incorrect! Lakonishok Equipment has an investment opportunity in Europe. Th ...
the answer in the box is incorrect!
Lakonishok Equipment has an investment opportunity in Europe. The project costs €9.5 million and is expected to produce cash flows of €1.6 million in Year 1, €2.1 million in Year 2 , and €3.2 million in Year 3. The current spot exchange rate is €.94/$ and the current risk-free rate in the United States is 2.3 percent, compared to that in Europe of 1.8 percent. The appropriate discount rate for the project is estimated to be 13 percent, the U.S. cost of capital for the company. In addition, the subsidiary can be sold at the end of three years for an estimated €7.8 million. What is the NPV of the project? (Do not round intermediate calculations and enter your answer in dollars, not in millions, rounded to 2 decimal places, e.g., 1,234,567.89.)
The solution is given belowTo calculate the Net Present Value (NPV) of this project, we need to first convert all cash flows from Euros to U.S. dollars using the current spot exchange rate. Then, we discount these cash flows back to present value using the appropriate discount rate (13%).
Let's first convert all the cash flows into U.S. dollars:
Initial cost: €9.5 million
Year 1 cash flow: €1.6 million * €.94/$ = $1.504 million
Year 2 cash flow: €2.1 million * €.94/$ = $1.974 million
Year 3 cash flow: €3.2 million * €.94/$ = $3.008 million
Sale of subsidiary at Year 3: €7.8 million * €.94/$ = $7.332 million
Please refer the above one