Question

Capital Budgeting Lakonishok Equipment has an investment opportunity in Europe. The project costs 19 million Euro an is expected to produce cash of 3.6 million euro in year 1, 4.1 million Euro in year 2, and 5.1 million Euro in year 3. The current spot exchange rate is $1.19/Euro and the current risk-free rate in the United States is 3.1 percent, compared to that in Europe of 2.9 percent. The appropriate discount rate for the project is estimated to be 10.5 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 12.7 million Euro. What is the NPV of the project?  

Answer 1

Exchange rate in each year = current spot exchange rate * ((1 + US risk free rate) / (1 + Euro risk free rate))n

where n = number of years from today

The Euro cash flows of each year are converted into USD at the exchange rate of that year

Euro cash inflow in year 3 = 5.1 million + 12.7 million = 17.8 million Euros

NPV is calculated using NPV function in Excel

NPV is $1,076,843