How do international factors affect decision making? Although the same basic principles of capital budgeting apply to both foreign and domestic operations, there are some key differences. For example, cash flows must be converted into the parent company’s currency, so they are subject to exchange rate risk. In addition, the cost of capital may be different for a foreign project compared with an equivalent domestic project.
For this Assignment, complete Problem 19-17, Parts a, b, and c on page 680 of your course text. This case examines the effects of exchange rates on net present values and rates of return.
FOREIGN CAPITAL BUDGETING Solitaire Machinery is a Swiss multinational manufacturing company. Currently, Solitaire’s financial planners are considering undertaking a 1-year project in the United States. The project’s expected dollar-denominated cash flows consist of an initial investment of $1,000 and a cash inflow the following year of $1,200. Solitaire estimates that its risk-adjusted cost of capital is 12%. Currently, 1 U.S. dollar will buy 0.90 Swiss franc. In addition, 1-year risk-free securities in the United States are yielding 5%, while similar securities in Switzerland are yielding 3.25%.
- a. If this project was instead undertaken by a similar U.S.-based company with the same risk-adjusted cost of capital, what would be the net present value and rate of return generated by this project?
- b. What is the expected forward exchange rate 1 year from now?
- c. If Solitaire undertakes the project, what is the net present value and rate of return of the project for Solitaire?