You want to invest in a riskless project in Spain. The project has an initial cost of 1.9 million Euros and is expected to produce cash inflows of 790,000 Euros per year at the end of the next three years. The project will be worthless after the third year. The expected inflation rate in Spain is 1.8%, while it is 4.8% in Canada. A risk-free security is paying 5.5% in Canada. The current spot rate is $1

Canadian = 0.72 Euros. Assume that the International Fisher Effect and the Uncovered Interest Parity both apply, where

Approximate International Fisher Effect: RCDN - hCDN = RFC - hEC

Approximate Uncovered Interest Parity: E[St] = So x [1 + (RFC - RCDN)It

The variables in these formulas are defined as

• RCDN = nominal risk-free rate in Canada
• Rec = nominal risk-free rate in foreign country
• hCDN = inflation rate in Canada
• hro = inflation rate in foreign country
  
  
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  • E/S+1 = projected exchange rate in t periods
  • Sp = spot exchange rate
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  1. What is the net present value of this project in Euros using the foreign currency approach?
  2. Using your answer in part (a), calculate the net present value of this project in Canadian dollars.
  3. What is the net present value of this project in Canadian dollars using the home currency approach?
  4. You will find that your answers in parts (b) and (c) are approximately but not exactly the same. Explain why this is so.