A professional accountancy institute in the UK is evaluating an investment project overseas in Eastasia, a politically stable country. The project involves the establishment of a training school to offer courses on international accounting and management topics. It will cost an initial 2.5 million Eastasian dollars (EA$) and it is expected to earn post-tax cash flows as follows:
Year ____________________1________ 2__________ 3__________ 4 _
Cash flow (EA$000) ..........750 ..........950 ..........1,250 ..........1,350
The following information is available:
• The expected inflation rate in Eastasia is 3 per cent a year.
• Real interest rates in the two countries are the same. They are expected to remain the same for the period of the project.
• The current spot rate is EA$2 per £1 sterling.
• The risk-free rate of interest in Eastasia is 7 per cent and in the UK 9 per cent.
• The company requires a sterling return from this project of 16 per cent.
(CIMA)
Required
Calculate the sterling net present value of the project using both the following methods:
(i) By discounting annual cash flows in sterling,
(ii) By discounting annual cash flows in Eastasian $.