You are analyzing a project with an initial cost of £130,000. The project is expected to return £20,000 the first year, £50,000 the second year, and £90,000 the third and final year. There is no salvage value. The current spot rate is £.6211. The nominal risk-free return is 5.5 percent in the U.K. and 6 percent in the U.S. The return relevant to the project is 14 percent in the U.S. Assume that uncovered interest rate parity exists. What is the net present value of this project in U.S. dollars
|
|
|
|
|
|
|
|
|
Answer: A : -$ 19,062
Working notes for the above answer is as under
E(S1)
= 0.6211 × [1 + (0.055 – 0.06)]1
=0.6179945
E(S2)
= 0.6211 × [1 + (0.055 – 0.06)]2
=0.614904528
E(S3)
= 0.6211 × [1 + (0.055 – 0.06)]3
=0.611830005
CF0
= -£130,000 × ($1/£0.6211)
= -$209,306.07
CF1
= £20,000 × ($1/£0.6179945)
=$32,362.75
CF2
= £50,000 × ($1/£0.614904528)
=$81,313.44
CF3
= £90,000 × ($1/£0.611830005)
=$147,099.68
Now let us find out NPV as follow
NPV
= -$209,306.07 + ($32,362.75/1.141)+ ($81,313.44/1.142) +($147,099.68/1.143)
= -$209,306.07 +$28,388.38 + $62,568.05 + $99,288.10
= -$19,062
