You are evaluating a proposed expansion of an existing subsidiary located in Switzerland. The cost of the expansion would be SF 27 million. The cash flows from the project would be SF 7.5 million per year for the next five years. The dollar required rate of return is 13% per year, and the current exchange rate is SF 1.72. The going rate on Eurodollars is 8% per year. It is 7 percent per year on Swiss Francs.
What do you project will happen to exchange rates over the next four years? Based on this hypothesis, convert the franc flows into dollar flows and calculate the NPV.
What is the required rate of return on franc flows? Based on this answer, calculate the NPV in francs and then convert to dollars.
Implicitly, it is assumed that interest rates won't change over the life of the project, but the exchange rate is projected to decline because the Euroswiss rate is lower than the Eurodollar rate.
We can use relative purchasing power ...
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