You are analyzing a project with an initial cost of £80,000. The project is expected to return £10,000 the first year,£40,000 the second year and £50,000 the third and final year. The current spot rate is £.56. The nominal risk-free return is 5 percent in the U.K. and 7 percent in the U.S. The return relevant to the project is 8 percent in the U.K. and 9.25 percent in the U.S. Assume that uncovered interest rate parity exists. What is the net present value of this project in U.S. dollars?

Question

Quizplus · Accepted Answer

Step 1: Calculate the present value of cash flows in pounds:

PV(year 1) = £10,000 / (1 + 0.08)^1 = £9,259.26
PV(year 2) = £40,000 / (1 + 0.08)^2 = £32,677.17
PV(year 3) = £50,000 / (1 + 0.08)^3 = £39,457.19

Total PV in pounds = £81,393.62

Step 2: Convert the total PV in pounds to U.S. dollars using the spot rate:

Total PV in dollars = £81,393.62 x 0.56 = $45,605.26

Step 3: Calculate the initial cost in dollars using the spot rate:

Initial cost in dollars = £80,000 x 0.56 = $44,800

Step 4: Calculate the net present value in dollars:

NPV in dollars = Total PV in dollars - Initial cost in dollars = $45,605.26 - $44,800 = $805.26

Step 5: Round the answer to the nearest dollar:

NPV in dollars = $80885. (Option E is the nearest)

You Are Analyzing a Project with an Initial Cost of £80,000