Question

A U.S. company is considering a project in Great Britain that would require an investment today of 5 million Pounds. The project would last 4 years and it would generate after-tax cash flows of 1.8 million Pounds per year. The company’s weighted average cost of capital is 10% per year, the U.S. risk-free interest rate is 5% per year, the British risk-free interest rate is 4% per year, and the spot exchange rate is 0.57 British Pounds per U.S. dollar. What is the net present value of the project in U.S. dollars? (I'm mainly trying to find the steps to the NPV in pounds)

1,496

2)

1,750,517

3)

997,795

4)

1,458,765

5)

2,100,621

Answer 1

By applying following steps we can calculate the NPV in pounds

a)First find out the implied cost of capital to discount the cash flows

Implied Cost of capital is roughly equals to the domestic curreny cost of capital adjusted for difference in interest rate

i.e.10%-(5%-4%)=9%

b)Find out the present value of Cash inflows

=after tax cash inflows*PVAF @9% for 4 years

=1.8million*3.23972

=5.831496 million

c)NPV

=Present value of Cash inflows-Initial investment

=5.831496 million-5 million

=0.831496 million Pounds

e)Now convert the NPV in pounds into dollar using spot rate

=0.831496/.57

=1.458765 million dollar

Thus NPV is ;

a)0.831496 million Pounds ;

b)1.458765 million dollar or $145,8765