QUESTION 1 20 marks

1. ABC Ltd, a U.K. multinational enterprise is contemplating making a foreign capital expenditure in South Africa. The initial cost of the project is ZAR50 million. The annual cash flows over the five-year economic life of the project are estimated to be ZAR13 million, ZAR18 million, ZAR25 million, ZAR10 million, and ZAR9 million. ABC Ltd's cost of capital in pounds () is 7.5 percent. The long-run inflation rate is forecasted to be 4 percent per annum in the U.K. and 12 percent in South Africa. The current spot foreign exchange rate is ZAR/ = 15.56.

Required:

(a) Calculate the NPV in ZAR using the ZAR equivalent cost of capital according to the Fisher Effect and then convert the ZAR NPV to at the current spot exchange rate. (5)

(b) Convert all cash flows from ZAR to at Purchasing Power Parity forecasted exchange rates and then calculate the NPV at the pound cost of capital. (7)

(c) What is the NPV in pounds if the actual pattern of ZAR/ exchange rates is: S(0) = 15.56, S(1) = 14.56, S(2) = 16.72, S(3) = 15.78, S(4) = 16.54, and S(5) = 16.32? Explain the difference in the actual and the forecasted NPV. (8)