Question 1

The only proper way to estimate the NPV of a foreign project is to discount the appropriate cash flows first and then convert them to the domestic currency at the current spot rate.

Accepted Answer

While the first step of discounting the cash flows is correct, the second step of converting them to the domestic currency at the current spot rate is not necessarily the only proper way. There are other factors to consider, such as currency fluctuations and the use of hedge instruments, which could affect the accuracy of the NPV estimate. Therefore, it is important to consider various approaches when estimating the NPV of a foreign project.

Question 2

When estimating a firm's cost of equity capital using the CAPM, you need to estimate

Accepted Answer

All of the above factors are necessary to estimate a firm's cost of equity using the CAPM. The risk-free rate of return represents the baseline rate of return that an investor could earn without taking on any risk. The expected return on the market portfolio represents the average return that investors could earn by investing in a diversified portfolio of all available securities. Lastly, the firm's beta measures its sensitivity to market movements and is used to adjust for the additional risk that the firm's equity has relative to the overall market.

Question 3

If a firm undertakes a project with ordinary cash flows and estimates that the firm has a negative NPV, then the IRR will be

Accepted Answer

If the firm estimates a negative NPV for a project with ordinary cash flows, it means that the cost of the project exceeds the present value of the expected cash flows. The IRR is the discount rate that makes the NPV of the project equal to zero. Therefore, if the NPV is negative, the IRR must be less than the cost of capital (the discount rate used to calculate the NPV).

Question 4

When a foreign project is analyzed from the parent's point of view, the additional risk that stems from it's "foreign" location is typically measured by ________ or ________.

Accepted Answer

The additional risk that comes from a foreign location is typically measured by adjusting the discount rates or adjusting the cash flows. This is because foreign projects are subject to additional risks such as political instability, currency fluctuations, and differences in the legal systems. Adjusting the discount rates involves increasing the required rate of return to compensate for the additional risk, while adjusting the cash flows involves estimating the impact of the additional risks on future cash flows. Therefore, option C is the best choice.

Question 5

Projects that have ________ are often rejected by traditional discounted cash flow models of capital budgeting.

Accepted Answer

All of the above factors (long lives, cash flow returns in later years, and high risk levels) can make projects appear less attractive when using traditional discounted cash flow models of capital budgeting. Long-lived projects result in a significant portion of cash flows occurring at the end of the project's timeline, leading to a lower net present value. Similarly, projects with cash flow returns in later years may have a lower present value when discounted to the present day. High-risk projects may have a discount rate that is too high, making the net present value less attractive. Thus, projects with these characteristics may be rejected by traditional DCF models.

Question 6

Use the information for the following question(s).
The Wheel Deal Inc., a company that produces scooters and other wheeled non-motorized recreational equipment is considering an expansion of their product line to Europe. The expansion would require a purchase of equipment with a price of euro 1,200,000 and additional installation of euro 300,000 (assume that the installation costs cannot be expensed, but rather, must be depreciated over the life of the asset). Because this would be a new product, they will not be replacing existing equipment. The new product line is expected to increase revenues by euro 600,000 per year over current levels for the next 5 years, however; expenses will also increase by euro 200,000 per year. (Note: Assume the after-tax operating cash flows in years 1-5 are equal, and that the terminal value of the project in year 5 may change total after-tax cash flows for that year.) The equipment is multipurpose and the firm anticipates that they will sell it at the end of the five years for euro 500,000. The firm's required rate of return is 12% and they are in the 40% tax bracket. Depreciation is straight-line to a value of euro 0 over the 5-year life of the equipment, and the initial investment (at year 0) also requires an increase in NWC of euro 100,000 (to be recovered at the sale of the equipment at the end of five years). The current spot rate is $0.95/euro, and the expected inflation rate in the U.S. is 4% per year and 3% per year in Europe.
-Refer to Instruction 17.1. What is the IRR of the Wheel Deal expansion?

Accepted Answer

The answer of Use the information for the following question(s).
The...

Question 7

Use the information to answer the following question(s).
Jensen Aquatics Inc., which manufactures and sells scuba gear worldwide, is considering an investment in either Europe or Great Britain. Consider the following cash flows for each project, assume a 12% wacc, and consider these to be average risk projects for the firm. Answer the questions that follow.
 
-Refer to Table 17.1. The NPV for the British investment is estimated at

Accepted Answer

The NPV for the British investment is estimated at $3,092. This is because the present value of the cash inflows is greater than the present value of the cash outflows.

Question 8

Which is NOT considered a shortcoming of the parent simply adjusting discount rates to account for the additional risk that stems from a project's foreign location?

Accepted Answer

The answer of Which is NOT considered a shortcoming of...

Question 9

Calculate the cost of equity for Boston Industries using the following information: The cost of debt is 5%, the corporate tax rate is 40%, the rate on Treasury Bills is 3.5%, the firm has a beta of 0.8, and the expected return on the market is 12%.

Accepted Answer

The correct answer is A because the cost of equity for Boston Industries can be calculated using the Capital Asset Pricing Model (CAPM), which states that the expected return on a stock is equal to the risk-free rate plus a risk premium. The risk premium is determined by the beta of the stock, which measures its volatility relative to the market. In this case, the risk-free rate is 3.5%, the beta is 0.8, and the expected return on the market is 12%. Therefore, the cost of equity for Boston Industries is 3.5% + 0.8 * (12% - 3.5%) = 10.3%.

Question 10

Use the information to answer the following question(s).
Jensen Aquatics Inc., which manufactures and sells scuba gear worldwide, is considering an investment in either Europe or Great Britain. Consider the following cash flows for each project, assume a 12% wacc, and consider these to be average risk projects for the firm. Answer the questions that follow.
 
-Refer to Table 17.1. If the euro was forecast to remain constant at $1.00/euro throughout the investment period, how would the investment decision now be characterized?

Accepted Answer

The answer of Use the information to answer the following...

Question 11

Generally speaking a firm's cost of ________ capital is greater than the firm's ________.

Accepted Answer

The cost of equity capital is typically higher than the weighted average cost of capital (WACC) for a firm. This is because the cost of equity capital is based on the expected return demanded by investors for the level of risk associated with the firm's stock, while WACC takes into account both the cost of equity and the cost of debt, which is usually lower than equity.

Question 12

Use the information to answer the following question(s).
Jensen Aquatics Inc., which manufactures and sells scuba gear worldwide, is considering an investment in either Europe or Great Britain. Consider the following cash flows for each project, assume a 12% wacc, and consider these to be average risk projects for the firm. Answer the questions that follow.
 
-Refer to Table 17.1. Which of the following best summarizes the preliminary results of the investment analysis for the two prospective investments?

Accepted Answer

The preliminary results indicate that both investments meet the criteria for acceptance, suggesting that both are viable options.

Question 13

Benson Manufacturing has an after-tax cost of debt of 7% and a cost of equity of 12%. If Benson is in a 30% tax bracket, and finances 40% of assets with debt, what is the firm's wacc?

Accepted Answer

The correct answer is A because the WACC is calculated as follows:WACC = (E/V) * Re + (D/V) * Rd * (1 - Tc)where:E = market value of equityV = total value of the firmRe = cost of equityD = market value of debtRd = cost of debtTc = corporate tax rateIn this case, we have:E/V = 1 - D/V = 1 - 0.40 = 0.60Re = 12%D/V = 0.40Rd = 7%Tc = 30%Therefore, the WACC is:WACC = (0.60) * 12% + (0.40) * 7% * (1 - 0.30)= 11.20%

Question 14

Use the information to answer the following question(s).
Jensen Aquatics Inc., which manufactures and sells scuba gear worldwide, is considering an investment in either Europe or Great Britain. Consider the following cash flows for each project, assume a 12% wacc, and consider these to be average risk projects for the firm. Answer the questions that follow.
 
-Refer to Table 17.1. The NPV for the European investment is estimated at

Accepted Answer

The answer of Use the information to answer the following...

Question 15

Use the information for the following question(s).
The Wheel Deal Inc., a company that produces scooters and other wheeled non-motorized recreational equipment is considering an expansion of their product line to Europe. The expansion would require a purchase of equipment with a price of euro 1,200,000 and additional installation of euro 300,000 (assume that the installation costs cannot be expensed, but rather, must be depreciated over the life of the asset). Because this would be a new product, they will not be replacing existing equipment. The new product line is expected to increase revenues by euro 600,000 per year over current levels for the next 5 years, however; expenses will also increase by euro 200,000 per year. (Note: Assume the after-tax operating cash flows in years 1-5 are equal, and that the terminal value of the project in year 5 may change total after-tax cash flows for that year.) The equipment is multipurpose and the firm anticipates that they will sell it at the end of the five years for euro 500,000. The firm's required rate of return is 12% and they are in the 40% tax bracket. Depreciation is straight-line to a value of euro 0 over the 5-year life of the equipment, and the initial investment (at year 0) also requires an increase in NWC of euro 100,000 (to be recovered at the sale of the equipment at the end of five years). The current spot rate is $0.95/euro, and the expected inflation rate in the U.S. is 4% per year and 3% per year in Europe.
-Refer to Instruction 17.1. In euros, what is the NPV of the Wheel Deal expansion?

Accepted Answer

To calculate the NPV in euros we need to convert all the cash flows into euros using the spot rate of $0.95/euro. Then we can use the NPV formula to calculate the NPV in euros. The NPV in euros is -euro 75,310. Therefore, the best choice is C, which is the only option with a negative NPV in euros.

Question 16

________ is the risk that a foreign government will place restrictions such as limiting the amount of funds that can be remitted to the parent firm, or even expropriation of cash flows earned in that country.

Accepted Answer

Political risk refers to the risk associated with a foreign government taking actions that could negatively impact a company's financial position or operations. This could include restrictions on remitting funds to the parent company, expropriation of cash flows, and other similar actions.

Question 17

Generally speaking, a firm wants to receive cash flows in a currency that is ________ relative to their own, and pay out in currencies that are ________ relative to their home currency.

Accepted Answer

A firm wants to receive cash flows in a currency that is appreciating relative to their own because it increases the value of their revenue. On the other hand, they want to pay out in currencies that are depreciating relative to their own because it reduces their expenses.

Question 18

Which of the following is NOT an example of political risk?

Accepted Answer

All of the options listed (A, B, and C) are examples of political risk, so option D is not a correct answer.

Question 19

When dealing with international capital budgeting projects, the value of the project is NOT sensitive to the firm repatriating dividends to its parent.

Accepted Answer

The value of the project is sensitive to the firm repatriating dividends to its parent as it affects the cash flows of the project and the overall return on investment. Repatriating dividends could also incur additional taxes and costs which affects the profitability of the project.

Question 20

Refer to Instruction 17.1. The European expansion would have a greater NPV in dollar terms if the euro appreciated in value over the five-year life of the project and the project had a positive NPV, other things equal.

Accepted Answer

If the euro appreciates in value over the five-year life of the project, the euro-denominated cash flows generated by the project would be worth more in dollar terms. This would increase the NPV of the project in dollar terms, assuming the project has a positive NPV.

Quiz 17: Multinational Capital Budgeting and Cross-Border Acquisitions