A Canadian firm is considering purchasing a subsidiary in Great Britain. The subsidiary will cost $\le$16 million and will generate cash inflows of $\le$7.6 million per year at the end of each of the next three years. After that, the company will be worthless. The current exchange rate is $\le$0.83 British pounds per $1. The Canadian inflation rate is expected to be 4% over this period. The current risk-free rate of interest in Canada is 5% and the risk-free rate in Great Britain is 8%.

What is the cash inflow for year 3 in terms of Canadian dollars?

Question

A Canadian firm is considering purchasing a subsidiary in Great Britain. The subsidiary will cost

\le

16 million and will generate cash inflows of

\le

7.6 million per year at the end of each of the next three years. After that, the company will be worthless. The current exchange rate is

\le

0.83 British pounds per $1. The Canadian inflation rate is expected to be 4% over this period. The current risk-free rate of interest in Canada is 5% and the risk-free rate in Great Britain is 8%.

What is the cash inflow for year 3 in terms of Canadian dollars?

What is the cash inflow for year 3 in terms of Canadian dollars?

Quizplus · Accepted Answer

To find the cash inflow for year 3 in Canadian dollars, first convert the British pound cash inflow to Canadian dollars using the exchange rate. Then, adjust for the inflation differential using the Fisher equation. The cash inflow in year 3 is £7.6 million, which is £7.6 million / 0.83 = $9.157 million. Adjusting for inflation differential, the real cash inflow is approximately $8.38 million.

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