Question 5. XYZ Corp is considering expanding to Europe and starting a project that costs e6M and is expected to generate e1.5M in year 1, e2.0M in year 2, and e2.5M in year 3. The current spot exchange rate is $1.13/e, the US risk-free rate is 2.5%, and the risk-free rate in Europe is 2.1%. Because this is a significantly riskier project than the domestic ones, it was estimated that the cost of capital is 15%. According to a recent market study commissioned by XYZ Corp, its believed that the European subsidiary can be sold at the end of the project for e5M.

(a) What are the pros and cons of an international project? What additional risks will the company likely face?

(b) What is the NPV of the project?

(c) What happens to the profits from the international project if the dollar strengthens? What if it weakens? How could the company hedge the exchange rate risk?

Statements Income Statement 40% Sales COGS Other expenses Depreciation EBIT Interest Taxable income Taxes (40%) Net income $43,000,000 $30,000,000 $5,000,000 $2,000,000 $6,000,000 $2,000,000 $4,000,000 $1,600,000 $2.400.000 Taxes: Shares Outstanding Market-to-Book Ratio Depreciation of New Assets Dividend growth in the last 7 years 1,000,000 1.25 25.00% 8.00% Dividends Add to RE $600,000 $1,800,000 Balance Sheet Assets Current Assets Cash Accounts Receivable Inventory Total CA Fixed Assets Net PP&E $500,000 $1,000,000 $2,000,000 $3,500,000 Liabilities & Owners' Equity Current Liabilities Accounts Payable Notes Payable Total CL Long Term Debt Owners' Equity Common Stock Retained Earnings Total Equity Total L & OE $1,000,000 $3,000,000 $4,000,000 $10,000,000 $25,000,000 $6,500,000 $8,000,000 $14,500,000 $28,500,000 Total Assets $28,500,000