Question
Foreign currency NPV approach . Farbucks is thinking of expanding to South Korea. The current indirect rate for dollars and South Korean won is 1,014
Foreign currency NPV approach.
Farbucks is thinking of expanding to South Korea. The current indirect rate for dollars and South Korean won is 1,014 won per dollar. The expected inflation rate in South Korea should hover near 0.4% for the next five years. The expected U.S. inflation rate should stay around 3.5%. The discount rate for expanding is 16% for Farbucks. Given the following projected cash flows for the expansion project, use the foreign currency NPV approach to determine whether Farbucks should expand to South Korea.
Year 0: initial investment costs of 85,000,000 won per coffee shop Year 1 cash flow:25,000,000 won Year 2 cash flow:35,000,000 won Year 3 cash flow:60,000,000 won Year 4 cash flow:80,000,000 won Year 5 cash flow:40,000,000 won |
Foreign currency approach in multinational capital budgeting consists of the following steps:
Step 1: Find the appropriate foreign discount rate.
Step 2: Find the present value of cash flow in foreign currency using the foreign discount rate.
Step 3: Find the net present value (NPV) in foreign currency (add up the present value of the cash outflow and inflow).
Step 4: Convert NPV in foreign currency to dollars using the current exchange rate.
Step 5: Accept the project if its NPV is positive and reject if negative.
First, complete step 1 by finding the appropriate foreign discount rate.
The discount rate for expanding is 16% for Farbucks. The inflation rate in South Korea is expected to hover near 0.4% for the next five years and the U.S. inflation rate is expected to stay around 3.5%. What is the discount rate in South Korea?
__%(Round to four decimal places.)
Second, complete step 2 by finding the present value of cash flow in foreign currency using the foreign discount rate.
What is the present value of CF1?
__won(Round to the nearest cent.)
What is the present value of CF2?
__won(Round to the nearest cent.)
What is the present value of CF3?
__won(Round to the nearest cent.)
What is the present value of CF4?
__won(Round to the nearest cent.)
What is the present value of CF5?
__won(Round to the nearest cent.)
Third, complete step 3 by finding the NPV in foreign currency (adding up the present value of the cash outflow and inflow).
What is the project's NPV in South Korean won?
__won(Round to the nearest cent.)
Finally, complete steps 4 and 5 by converting NPV into dollars and applying the NPV decision rule.
Should Farbucks expand to South Korea?(Select the best response.)
A. Yes, Farbucks should expand to South Korea because the project's NPV is $77,949.
B. Yes, Farbucks should expand to South Korea because the project's NPV is $74,449.
C. Yes, Farbucks should expand to South Korea because the project's NPV is $82,249.
D. Yes, Farbucks should expand to South Korea because the project's NPV is $80,749.
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