Local Australian business ActiveShare Ltd. A new project with a different risk profile than its core operations is being considered by ActiveShare Ltd. In other words, the new initiative is riskier than the company's current ones. • A European supplier will be used to buy new equipment for the project. Two payments are required per the purchase agreement for the new equipment: a down payment of €40,000 in year 0 and a second payment of €3,500,000 at the conclusion of year 1. The current spot exchange rate is AUD1.48/€.

In addition to the payment of equipment, the other expected incremental after-tax cash flows of the project are given below:

Year	Project
1	$1,950,000
2	$1,930,000
3	$1,870,000
4	$2,060,000

The corporate treasurer has concluded that the following certainty equivalent coefficients apply to each of the risky cash flows for the project:

Year	Project
0	1.00
1	0.97
2	0.95
3	0.92
4	0.88

The current risk-free rate for Australian dollars is 2.5% per annum. The current risk-free rate for the European euro is 1.0% per annum. ActiveShare's cost of capital is 12%. ActiveShare's treasurer thinks that the riskiness of this new project warrants a 4.10% risk premium

 

Required:

a) Calculate the arbitrage-free one-year forward exchange rate (write at least five digits) 

b) Convert the euro-denominated payments to Australian dollars. 

c) Suppose ActiveShare enters into a currency forward contract to hedge its foreign exchange risk associated with the payment due in one year. Estimate the net present value of the project using the certainty equivalent method. Should the firm undertake the project?