Question

A bank considered opening three new branches in China. To do so they would need to borrow funds, and as interest rates are lower in Australia, they plan to borrow in Australian Dollars. The bank has used a Net Present Value (NPV) financial model to estimate its returns from this investment.

Required: Describe how the following changes would affect the bank’s financial model.

• Increase in Australian interest rates.
• Depreciation of the Australian Dollar (AUD) against Chinese Renminbi (CNY).
• An increase in capital requirements for banks in China.

Answer 1

An increase in Australian interest rates will increase the cost of borrowings for the bank and also the cash outflow will increase to account for the increase in the interest expense, thus the NPV will reduce for the bank, hence the attractiveness of the investment reduces.

Depreciation of AUD against CNY after borrowing of AUD will result in decreased outflow of CNY on account of repayment and interest, thus the NPV of the project will increase in CNY as a result the opening of branches becomes a more attractive investment.

An increase in capital requirements would imply more investment to keep up with the capital requirements, as such the profitability(Return on equity) of the bank may decrease and the NPV will decrease as the investment amount is increased, and if doesn’t leads to generation of new business, NPV will fall and project will become less attractive.