Assume that Vans Corporation is considering the establishment of a subsidiary in Norway. The initial investment is $5,000,000. If the project is undertaken, Vans would terminate the project after four years. Vans' cost of capital is 15%, and the project is of the same risk as Vans' existing projects, so they decide to take 15% as required rate of return. All cash flows generated from the project will be remitted to the parent at the end of each year. Listed below are the estimated cash flows the Norwegian subsidiary will generate over the project's lifetime in Norwegian kroner (NOK):
Year 1 |
Year 2 |
Year 3 |
Year 4 |
NOK10,000,000 |
NOK15,000,000 |
NOK17,000,000 |
NOK20,000,000 |
The current exchange rate of the Norwegian kroner is $.135. Vans' exchange rate forecast for the Norwegian kroner over the project's lifetime is listed below:
Year 1 |
Year 2 |
Year 3 |
Year 4 |
$.13 |
$.14 |
$.12 |
$.15 |
Assume that in year 4’s cash flow, NOK10,000,000 represents the salvage value. Vans is not completely certain that the salvage value will be this amount and wishes to determine the break-even salvage value. Calculate this break-even salvage value in U.S. dollar.
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