Question

Manzetti? Foods, a U.S. food processing and distribution? company, is considering an investment in Germany. You are in? Manzetti's corporate finance department and are responsible for deciding whether to undertake the project. The expected free cash? flows, in? euros, are uncorrelated to the spot exchange rate and are shown?here:

Year	0	1	2	3	4
Free Cash Flow ?(euro€ ?million)	?20.2	7	6	8	15

The new project has similar dollar risk to? Manzetti's other projects. The company knows that its overall dollar WACC is 8.62%?, so it feels comfortable using this WACC for the project. The? risk-free interest rate on dollars is 5.47 % and the? risk-free interest rate on euros is 3.46%.

a. Manzetti Foods is willing to assume that capital markets in the United States and the European Union are internationally integrated. What is the? company's euro? WACC?

b. What is the present value of the project in? euros?

Answer 1

Risk Free Interest rate R (euro) = 3.46%

Risk Free Interest rate R ($) = 5.47%

Using Approximation formula for initerest parity we know

R(euro) - R($) = 3.46 % - 5.47% = -2.01 %

Since, US & Euro capital market is integrated, then market premium and Beta ( unsystematic risk) will be same. hence, whatevetr wil be the difference in risk free rate will be translated to WACC.

WACC ( Euro) = WACC ( $) - 2.01 % = 8.62% -2.01 % = 6.61%

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NPV (euro) = - 20.2 + 7 /(1+6.61%) + 6 /(1+6.61%)² + 8 /(1+6.61%)³ + 15 /(1+6.61%)⁴

= 9.8591 Euro