A U.S corporation invests in Canada for a solar system project. The project requires initial outlays of Canadian dollars CAD13,500. Use the following information to answer the questions.

Cost of capital (in USD): 8.5 percent U.S. inflation rate: 3.2 percent Canada inflation rate: 4 percent Spot rate: CAD 1.45/$.

Expected cash flow for Year 1: CAD 3,800 Year 2: CAD 4,800 Year 3: CAD 5,800 Year 4: CAD 6,800

a) Calculate the Canadian dollar equivalent cost of capital according to the Fisher effect theory.

(3 marks)

b) Calculate the highest cost of capital that the manager can tolerate in accepting the project in CAD.

(3 marks)

c) Compare your answer in (b) with the given cost of capital. Explain how does the difference give you additional confidence for accepting the project.

(5 marks)

d) In theoretical point of view, do you think the projects NPVs in two different currencies (CAD and USD) would be different? Explain.(4 marks)

e) Prove your explanation in part (d) using numerical analysis.

(5 marks)