You are analyzing a project with an initial cost of £45,000. The project is expected to return £8,000
the first year, £22,000 the second year and £20,000 the third and final year. The current spot rate is£.57. The nominal risk-free return is 5.5 percent in the U.K. and 4.5 percent in Canada. The return relevant to the project is 9 percent in the U.K. and 10.5 percent in Canada. Assume that uncovered Interest rate parity exists. What is the net present value of this project in Canadian dollars?

Question

Quizplus · Accepted Answer

The correct answer is A because the net present value of the project in Canadian dollars is -$10,144. This is calculated by first converting the initial cost and the cash flows into Canadian dollars using the spot rate of £.57. The initial cost in Canadian dollars is £45,000 * £.57 = $25,650. The cash flows in Canadian dollars are:Year 1: £8,000 * £.57 = $4,560Year 2: £22,000 * £.57 = $12,540Year 3: £20,000 * £.57 = $11,400The net present value of the project is then calculated using the relevant discount rate of 10.5 percent in Canada. The net present value is:NPV = -$25,650 + $4,560 / (1 + 10.5%) + $12,540 / (1 + 10.5%)^2 + $11,400 / (1 + 10.5%)^3= -$10,144

You Are Analyzing a Project with an Initial Cost of £45,000