Delta Company, a U.S. MNC, is contemplating making a foreign capital expenditure in South Africa. The initial

Question:

Delta Company, a U.S. MNC, is contemplating making a foreign capital expenditure in South Africa. The initial cost of the project is ZAR10,000. The annual cash flows over the five-year economic life of the project in ZAR are estimated to be 3,000,4,000,5,000,6,000, and 7,000. The parent firm's cost of capital in dollars is 9.5 percent. Long-run inflation is forecasted to be 3 percent per annum in the United States and 7 percent in South Africa. The current spot foreign exchange rate is ZAR/USD = 3.75. Determine the NPV for the project in USD by:

a. Calculating the NPV in ZAR using the ZAR equivalent cost of capital according to the Fisher effect and then converting to USD at the current spot rate.

b. Converting all cash flows from ZAR to USD at purchasing power parity forecasted exchange rates and then calculating the NPV at the dollar cost of capital.

c. Are the two dollar NPVs different or the same? Explain.

d. What is the NPV in dollars if the actual pattern of ZAR/USD exchange rates is:

S(0) = 3.75, S(1) = 5.7, S(2) = 6.7, S(3) = 7.2, S(4) = 7.7, and S(5) = 8.2?

Cost Of Capital
Cost of capital refers to the opportunity cost of making a specific investment . Cost of capital (COC) is the rate of return that a firm must earn on its project investments to maintain its market value and attract funds. COC is the required rate of... Exchange Rate
The value of one currency for the purpose of conversion to another. Exchange Rate means on any day, for purposes of determining the Dollar Equivalent of any currency other than Dollars, the rate at which such currency may be exchanged into Dollars... Fisher Effect
The Fisher Effect is an economic theory created by economist Irving Fisher that describes the relationship between inflation and both real and nominal interest rates. The Fisher Effect states that the real interest rate equals the nominal interest...