Question

You are a financial analyst for a US based multinational company, and you are in the process of putting together a proposal for a foreign investment in South America. You have been tasked with estimating the cash flows from the proposed investment, calculating its NPV, and making a recommendation about the project. In accordance with standard practice, you have calculated the project’s NPV from two viewpoints: (i) from the parent company’s viewpoint and (ii) the local viewpoint, also referred to as the project viewpoint.

Suppose that your analysis reveals that the NPV as computed from the parent company’s viewpoint is positive, but that the NPV as computed from the local or project viewpoint is negative. Give two reasons why this might occur. Would you recommend that the project should be accepted or rejected? Explain your answer.

Answer 1

Say, The project is of tenure 1 year. Initial investment is $90 and revenue is 100$ after 1 year. Required rate of return is 10%.

So, as an US company the NPV= 100/1.1 - 90=$.91 i.e return around 1%

For the local point of view this project can be negative if the dollar is strengthened after 1 year i.e. at the time of completion of project.

Suppose, The initial exchange rate at the begining of project is =5 local currency/$ and at completion of project the exchange rate is 6 local currency/$

So, initial investment= 5*90=450 local currency and if return is 1% then revenue will be (450+4.5) or 500.5 local currency(using 10% required rate of return). So, here dollar return is = 500.5/6-90= -6.6$. So, here if we involve local point of view the return becomes negative.

As per my opinion this kind of project should be rejected as there is chance of making loss in terms of local point of view.