Question

You are analyzing a project with an initial cost of £50,000. The project is expected to return £12,000 the first year, £36,000 the second year, and £40,000 the third and final year. There is no salvage value. Assume the current spot rate is £.6346. The nominal return relevant to the project is 12 percent in the U.S. The nominal risk-free rate in the U.S. is 3.4 percent while it is 4.1 percent in the U.K. Assume that uncovered interest rate parity exists. What is the net present value of this project in U.S. dollars?

$23,611

$26,509

$26,930

$29,639

$30,796

Answer 1

E(S1) = 0.6346 x [1 + (0.041 - 0.034)]¹ = 0.6390422

E(S2) = 0.6346 x [1 + (0.041 - 0.034)]² = 0.643515495

E(S3) = 0.6346 x [1 + (0.041 - 0.034)]³ = 0.648020104

CF0= -£50,000 ($1/£0.6346) = -$78,789.79

C01 = £12,000 ($1/£0.6390422) = $18,778.10

C02 = £36,000 ($1/£0.643515495) = $55,942.71

C03 = £40,000 ($1/£0.648020104) = $61,726.48

NPV = PV of Cash Inflows - PV of Cash Outflows

= [$18,778.10/1.12] + [$55,942.71/1.12²] + [$61,726.48/1.12³] - $78,789.79

= $16,766.16 + $44,597.19 + $43,935.69 - $78,789.79 = $26,509.25

Hence, Option "B" is correct.