Question (12 marks)

The Sydney-headquartered MNE Ltd. is evaluating a proposed expansion of an existing subsidiary located in the UK. The cost of the expansion would be GBP 25 million. The cash flows from the project would be GBP 7.5 million per year over the next four years. The Australian dollar required return is 9 per cent per year and the current exchange rate is AUD1.8000/GBP. The interest rate for the next five years is forecasted to be 0.5 percent per year in the UK and 1.25 percent per year in Australia.

Required:

(a) Do you expect the exchange rates between AUD and GBP to rise or fall over the next four years? Briefly explain. (No calculation is required for this part) (1.5 marks)

(b) Convert the projected GBP cash flows into Australian dollar cash flows and calculate the NPV. Keep four decimal points when calculating forward exchange rates. (8.5 marks)

(c) What would be the appropriate discount rate for the expansion if the foreign currency approach is used to calculate NPV? (2 marks)