You want to invest in a project in Canada. The project has an initial cost of C$1.6 million and is expected to produce cash inflows of C$750,000 a year for 3 years. The project will be worthless after the first 3 years. The expected inflation rate in Canada is 5 % while it is only 3.5 % in the U.S. The applicable interest rate for the project in Canada is 12 %. The current spot rate is C$1 = $0.8637. What is the net present value of this project in Canadian dollars using the foreign currency approach?

Question

Quizplus · Accepted Answer

To calculate the net present value (NPV) of the project in Canadian dollars using the foreign currency approach, we first need to calculate the present value (PV) of the cash inflows and then subtract the initial cost. The formula for the present value of an annuity (since the cash inflows are equal each year) is PV = C * [(1 - (1 + r)^-n) / r], where C is the annual cash inflow, r is the discount rate (interest rate in this case), and n is the number of years.Given:- Annual cash inflow (C) = C$750,000- Interest rate (r) = 12% or 0.12- Number of years (n) = 3- Initial cost = C$1.6 millionFirst, calculate the present value of the cash inflows:PV = C$750,000 * [(1 - (1 + 0.12)^-3) / 0.12] = C$750,000 * [(1 - (1 + 0.12)^-3) / 0.12] ≈ C$1,801,373Then, subtract the initial cost to get the NPV:NPV = PV - Initial cost = C$1,801,373 - C$1,600,000 ≈ C$201,373Therefore, the correct answer is B) C$201,373.

You Want to Invest in a Project in Canada