You currently live in Land-of-Leisure (currency is the leisure-unit L), and you are considering investing in a diploma-printing shop in a foreign country called Land-ofWork (currency is the work-unit W). Financial markets are perfect and the international parity conditions hold in these two countries. The print-shop investment will be financed with 100 percent equity. Interest and inflation rates are as follows.

Leisure Work Nominal risk-free government T-bill rate Real required return on T-bills Expected inflation Real required return on a print-shop project The spot rate is W100/L and the following information is known:

The project lasts two years. Operating cash flows are received at year-end.

A W200,000 investment purchases the land for the print shop. The real value of the land will remain constant throughout the life of the project. The land will be sold at the end of the project.

The shop and printing press will cost W200,000, payable at the start of the project. The shop and printing press will be owned by the foreign subsidiary and depreciated on a straight-line basis over two years to a zero salvage value.

The shop and printing press are expected to have zero market value at the end of two years.

No investment in working capital is necessary.

Diplomas sell for W200 in Land-of-Work. The price is expected to remain constant in real terms. Annual sales are expected to be 2,000 diplomas per year in each of the next two years.

Variable operating costs are 20 percent of sales.

Fixed operating costs are W45,000 in the first year and will grow at the inflation rate thereafter.

Income and capital gain taxes are 50 percent in each country.

Assume all operating cash flows occur at the end of the year.

a. What is the nominal required return on print-shop projects in L? in W?

b. Identify expected future exchange rates for each of the next two years.

c. Identify expected future cash flows on this foreign investment project. Discount these cash flows at the work-unit discount rate from part

(a) to find V0 L

|iW.

d. Translate the work-unit cash flows to leisure-units at the expected future spot rates from part (b). Discount these cash flows at the leisure-unit discount rate from part

(a) to find . Is the answer the same as in part

(c)? Why?