A foreign project generates a negative cash flow in year 1 and positive cash flows in years 2 through 5. The NPV for this project will be higher if the foreign currency ____ in year 1 and ____ in years 2 through 5.

Question

Quizplus · Accepted Answer

If the foreign currency depreciates in year 1, the negative cash flow will convert into a higher amount when converted back to the domestic currency, resulting in a lower net present value (NPV) of the project. However, if the foreign currency appreciates in years 2 through 5, the positive cash flows will convert into a higher amount when converted back to the domestic currency, resulting in a higher NPV for the project. Therefore, a depreciating foreign currency in year 1 and an appreciating foreign currency in years 2 through 5 will lead to the highest NPV for the foreign project.

A Foreign Project Generates a Negative Cash Flow in Year