Question

Quantitative Problem: International Machinery Company (IMC) is a Swedish multinational manufacturing company. Currently, IMC's financial planners are considering undertaking a 1-year project in the United States. The project's expected dollar-denominated cash flows consist of an initial investment of $2,900 and a cash inflow the following year of $3,750. IMC estimates that its risk-adjusted cost of capital is 19%. Currently, 1 U.S. dollar will buy 9.0 Swedish kronas. In addition, 1-year risk-free securities in the United States are yielding 5%, while similar securities in Sweden are yielding 4%.

a.) If the interest parity holds, what is the forward exchange rate of Swedish kronas per U.S. dollar? Do not round intermediate calculations. Round your answer to four decimal places.

___________ Swedish kronas per U.S. dollar

b.) If IMC undertakes the project, what is the net present value and rate of return of the project for IMC in home currency? Do not round intermediate calculations. Round your answers to two decimal places.

NPV: ____________Swedish kronas

Rate of return: __________%

Answer 1

Part (a):

With covered interest rate parity, F= (1+id)*S/(1+if)

Where F= Forward foreign exchange rate, id= domestic interest rate, S= Spot exchange rate and if= interest rate in foreign currency.

Given,

Interest rate in Sweden (id)= 4%

Interest rate in US (if)= 5%

Spot exchange rate (S)= 9 Swedish Kronas per Dollar

Therefore, Forward rate= (1+0.04)*9/(1+0.05) = 8.9143 Swedish Kronas per Dollar

Part (b):

Given, investment = $2,900

Investment in Swedish Kronas= $2,900*Spot rate= $2,900*9 = 26,100 Swedish Kronas

Cash Flow one year= $3,750

Cash flow in Swedish Kronas= $3,750* Forward rate= $3,750*8.9143 = 33,428.6250 Kronas

NPV= PV of Cash flow- Investment= [33,428.6250/(1+0.19)]-26,100

= 28,091.28151-26,100 = 1991.28 Swedish Kronas

Rate of Return= (Cash Flow/Investment)-1 = 33,428.6250/26,100 = 0.28079 or, 28.08%