1. BRENAN Company, a U.S. MNC, is contemplating making a foreign capital expenditure in China. The initial cost of the project is Renminbi (RMB) 10,000. The annual cash flows over the five-year economic life of the project in RMB is estimated to be 2,000, 4,000, 6,000, 7000, and 8,000. The risk free rate in US is 2% and the beta of the company is 1.5 and the market return is 7%. Long-run inflation is forecasted to be 3 percent per annum in the U.S. and 7 percent in China. The current spot foreign exchange rate is RMB /USD = 3.75. Determine the NPV for the project in USD by: (a) Calculating the NPV in RMB using the RMB equivalent cost of capital according to the Fisher Effect and then converting to USD at the current spot rate. [10 marks] (b) Converting all cash flows from RMB to USD at Purchasing Power Parity forecasted exchange rates and then calculating the NPV at the dollar cost of capital. Are they same or different? Explain. [10 marks] (c) "Financial managers should regularly hedge their foreign exchange exposure, if the forward unbiased condition holds". Is this statement true or false? Explain. [15 marks] (d) Empirical evidence has shown at times deviations from Interest Rate Parity and the Fisher International Effect. In what kind of hazards and opportunities are financial managers exposed to? [15 marks] 1. BRENAN Company, a U.S. MNC, is contemplating making a foreign capital expenditure in China. The initial cost of the project is Renminbi (RMB) 10,000. The annual cash flows over the five-year economic life of the project in RMB is estimated to be 2,000, 4,000, 6,000, 7000, and 8,000. The risk free rate in US is 2% and the beta of the company is 1.5 and the market return is 7%. Long-run inflation is forecasted to be 3 percent per annum in the U.S. and 7 percent in China. The current spot foreign exchange rate is RMB /USD = 3.75. Determine the NPV for the project in USD by: (a) Calculating the NPV in RMB using the RMB equivalent cost of capital according to the Fisher Effect and then converting to USD at the current spot rate. [10 marks] (b) Converting all cash flows from RMB to USD at Purchasing Power Parity forecasted exchange rates and then calculating the NPV at the dollar cost of capital. Are they same or different? Explain. [10 marks] (c) "Financial managers should regularly hedge their foreign exchange exposure, if the forward unbiased condition holds". Is this statement true or false? Explain. [15 marks] (d) Empirical evidence has shown at times deviations from Interest Rate Parity and the Fisher International Effect. In what kind of hazards and opportunities are financial managers exposed to? [15 marks]
