Rollerblade, a manufacturer of skating gear, plans to expand its operation in Brighton, England. The expansion will cost $18.5 million and is expected to generate annual net cash flows of 2.2 million pounds for a period of 15 years and nothing thereafter. The cost of capital for the project is 16%. Using the spot exchange rate of $1.60 per British pound, compute the net present value of the expansion project.

Question

Quizplus · Accepted Answer

1. Convert the expected annual net cash flow from pound to dollars using the spot exchange rate:

2.2 million pounds x $1.60 per pound = $3.52 million

2. Calculate the net present value using the formula:

NPV = -Initial investment + Present value of expected net cash flows

NPV = -$18.5 million + [$3.52/(1+0.16)^1 + $3.52/(1+0.16)^2 + … + $3.52/(1+0.16)^15]

NPV = $1.124 million

Therefore, the net present value of the expansion project is $1.124 million, which means the project is expected to generate a positive return and should be accepted. Choice C is the correct answer.

Rollerblade, a Manufacturer of Skating Gear, Plans to Expand Its