# A German company manufactures a specialized piece of equipment and leases it to a U.K. enterprise. The

## Question:

A German company manufactures a specialized piece of equipment and leases it to a U.K. enterprise. The lease calls for five end-of-year payments of £1.1 million. The German firm spent €3.8 million to produce the equipment, which is expected to have no salvage value after five years. The current spot rate is €1.3/£. The risk-free interest rate is 3% in Germany and is 5% in the United Kingdom. The German firm reasons that the appropriate (German) discount rate for this investment is 7%. Calculate the NPV of this investment in two ways.

a. Convert all cash flows to pounds and then discount at an appropriate (U.K.) cost of capital. Round your answer to the nearest whole pound £

Convert the resulting NPV to Euros at the spot rate. Round your answer to the nearest whole Euro.

b. Calculate forward rates for each year, convert the pound-denominated cash flows into Euros using those rates, and then discount the cash flows at the German cost of capital. Round your answer to the nearest whole euro.

Salvage Value
Salvage value is the estimated book value of an asset after depreciation is complete, based on what a company expects to receive in exchange for the asset at the end of its useful life. As such, an asset’s estimated salvage value is an important...
Discount Rate
Depending upon the context, the discount rate has two different definitions and usages. First, the discount rate refers to the interest rate charged to the commercial banks and other financial institutions for the loans they take from the Federal...
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