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Your employer is a Canadian manufacturing firm that is considering opening a plant in the euro area. You are responsible for computing the NPV of

Your employer is a Canadian manufacturing firm that is considering opening a plant in the euro area. You are responsible for computing the NPV of the new project to facilitate the decision to take or pass on the expansion. The estimated free cash flows in euro presented below are assumed to be uncorrelated with the Canadian dollars (CDN) per euro () exchange rate:

Year Free cash flow (Millions of )

0

-125

1

60
2 70
3 75
4 75

The firm feels that the project is of similar risk to its existing portfolio of projects and, thus, the weighted average cost of capital (WACC) applicable to cash flows in Canadian dollars, 7%, is appropriate. The firm also believes that the capital markets of Canada and the EU are fully integrated.

  1. If the risk-free interest rate for Canadian dollars is 2% and the risk-free interest rate for euro is 0.5%, explain what is the appropriate WACC for the estimated project cash flows in the table.
  2. Compute the NPV of the project.

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