International Financial Management 6th Edition by Sanjiv Eun, Cheol Resnick, Bruce Sabherwal

Exercise 9

Delta Company, a U.S. MNC, is contemplating making a foreign capital expenditure in South Africa. The initial cost of the project is ZAR10,000. The annual cash flows over the five year economic life of the project in ZAR are estimated to be 3,000, 4,000, 5,000, 6000, and 7,000. The parent firm's cost of capital in dollars is 9.5 percent. Long-run inflation is forecasted to be 3 percent per annum in the U.S. and 7 percent in South Africa. The current spot foreign exchange rate is ZAR/USD = 3.75. Determine the NPV for the project in USD by:
a. Calculating the NPV in ZAR using the ZAR equivalent cost of capital according to the Fisher Effect and then converting to USD at the current spot rate.
b. Converting all cash flows from ZAR to USD at Purchasing Power Parity forecasted exchange rates and then calculating the NPV at the dollar cost of capital.
c. Are the two dollar NPVs different or the same Explain.
d. What is the NPV in dollars if the actual pattern of ZAR/USD exchange rates is: S(0) = 3.75, S(1) = 5.7, S(2) = 6.7, S(3) = 7.2, S(4) = 7.7, and S(5) = 8.2