# Question

A German company manufactures a specialized piece of manufacturing equipment and leases it to a U.K. enterprise. The lease calls for five end-of-year payments of £1 million. The German firm spent €3.5 million to produce the equipment, which is expected to have no salvage value after five years. The current spot rate is €1.5/£. The risk-free interest rate in Germany is 3 percent, and in the United Kingdom it is 5 percent. The German firm reasons that the appropriate (German) discount rate for this investment is 7 percent. Calculate the NPV of this investment in two ways.

a. First, convert all cash flows to pounds, and discount at an appropriate (U.K.) cost of capital. Convert the resulting NPV to euros at the spot rate.

b. Second, calculate forward rates for each year, convert the pound-denominated cash flows into euros using those rates, and discount at the German cost of capital. Verify that the NPV obtained from this approach matches (except perhaps for small rounding errors) that obtained in part (a).

a. First, convert all cash flows to pounds, and discount at an appropriate (U.K.) cost of capital. Convert the resulting NPV to euros at the spot rate.

b. Second, calculate forward rates for each year, convert the pound-denominated cash flows into euros using those rates, and discount at the German cost of capital. Verify that the NPV obtained from this approach matches (except perhaps for small rounding errors) that obtained in part (a).

## Answer to relevant Questions

Explain the difference between the stock price, the exercise price, and the option premium. Which of these are market prices determined by the forces of supply and demand? Explain the difference between a long position and a short position. Considering call options, what is the maximum gain and loss possible for an investor who holds the long position? What is the maximum gain and loss for the ...Suppose that Lisa Emerson owns a share of Zytex Chemical stock which is worth $100 per share. Lisa purchases a put option on this stock with a strike price of $95 and she sells a call option with a strike price of $105. Plot ...Why do you think European governments and stock exchanges want to promote a vibrant entrepreneurial sector? Can you think of any competitive advantages that may accrue to Europe, due to its relatively late start in ...Which industries do you anticipate will experience industry shocks that will spur merger activity in the near future?Post your question

0