Question: 1 st Mini case study on capital budgeting and cost of capital in international finance You have been appointed by your parent company in US
1st Mini case study on capital budgeting and cost of capital in international finance
You have been appointed by your parent company in US to conduct a cross border investment appraisal. You are given the following materials. An investment project in China yields these expected after-tax renminbi cash flows (in millions).
| Time | Cash flow (mil) |
| 0 | -Ren1000 |
| 1 | Ren200 |
| 2 | Ren500 |
| 3 | Ren300 |
| 4 | Ren100 |
| 5 | Ren50 |
| 6 | Ren 50 |
| 7 | Ren 50 |
| 8 Salvage value | Ren 300 |
The expected inflation in China is 3.2% while in US it is estimated to be 6.5%. The real return in both countries is estimated to be equal to 8.5%. The spot exchange rate eo is $0.5556/Ren.
- Assuming international parity holds. Calculate the NPV in dollars by first computing the NPV in renminbi and then converting into dollars at the current spot rate. (Method 1)
- Assuming the international parity holds. Calculate the NPV in dollars by converting the cash flows in renminbi into dollars at the expected future spot rates and then computing the NPV in dollars. (Method 2)
- Suppose the expected future spot rates are as follow:
| Time | Expected future spot rate ($/Ren) |
| 1 | e1 = $0.5801 |
| 2 | e2= $0.6089 |
| 3 | e3= $0.6392 |
| 4 | e4= $0.592 |
| 5 | e5= $0.632 |
| 6 | e6 = $0.632 |
| 7 | e7=$0.632 |
| 8 | e8 = $0.632 |
Compute the NPV as in (a) and (b)
- Suppose the expected future spot rates are as follow:
| Time | Expected future spot rate |
| 1 | e1 = $0.5575 |
| 2 | e2= $0.5625 |
| 3 | e3= $0.5676 |
| 4 | e4= $0.5675 |
| 5 | e5= $0.567 |
| 6 | E6= $0.566 |
| 7 | E7= $0.566 |
| 8 | E8= $0.566 |
Compute the NPV as in (a) and (b).
- Perform sensitivity analysis by changing the parameters as decided by you and team members.
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