UNSW Business School

FINS3616 International Business Finance

Term 1 2019
Capital Budgeting Practice Problems
 FINS3616 Capital Budgeting Practice Problems

The following information is used for the next TWO questions.

You work for a firm whose home currency is the Russian ruble (RUB) and that is
considering a foreign investment. The investment yields expected after-tax euro
(EUR) cash flows (in millions) as follows:

Year 0 Year 1 Year 2 Year 3

−EUR1,000 EUR450 EUR450 EUR450

Expected inflation is 9.0% in the Russian ruble and 11.0% in the euro. Assume
that the international parity conditions hold.
Required returns for projects in this risk class are:

• iRUB = 20.0% in Russian ruble; and

• iEUR = 22.2018% in euro

RUB/EUR
The spot exchange rate is S0 = RUB 72.500/EUR.
Question 1

What is the NPV of the investment from the parent’s perspective? That is, cal-
culate NPVRUB
0 |iRUB by first converting the euro future cash flows into Russian
ruble equivalents at expected future spot rates (based on relative PPP) and then
discount these cash flows at the appropriate risk-adjusted rate in the Russian
ruble.

Question 2

What is the NPV of the investment from the project’s perspective? That is, cal-
culate NPVRUB
0 |iEUR by discounting the euro cash flows at the appropriate risk-
adjusted euro discount rate and then convert this value into Russian ruble at the
today’s current spot rate.

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 FINS3616 Capital Budgeting Practice Problems

The following information is used for the next THREE questions.

You work for a firm whose home currency is the Swiss franc (CHF) and that is
considering a foreign investment. The investment yields expected after-tax British
pound (GBP) cash flows (in millions) as follows:

Year 0 Year 1 Year 2 Year 3

−GBP900 GBP400 GBP400 GBP400

Expected inflation is 13.0% in the Swiss franc and 6.0% in the British pound.
Required returns for projects in this risk class are:

• iCHF = 19.3% in the Swiss franc; and

• iGBP = 22.3% in the British pound

CHF/GBP
The spot exchange rate is S0 = CHF 1.4206/GBP.
Question 3

What is the NPV of the investment from the project’s perspective?

Question 4

What is the NPV of the investment from the parent’s perspective?

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Question 5

What is the correct course of action for the managers of the firm?

a. Accept the project and then, depending on the corporation’s tolerance for
risk, potentially leave the investment unhedged to take advantage of the
expected real appreciation of the project’s local currency (the British pound)
against the parent company’s home currency (the Swiss franc).
b. Accept the project and then hedge or otherwise capture the project’s value
if possible, as leaving the project unhedged is expected to reduce the magni-
tude of the positive NPV for the parent due to the forecast real depreciation
of the British pound against the Swiss franc.
c. Accept the project only if it is possible to hedge or otherwise structure
the deal to lock in the positive British pound project value in the parent
company’s domestic Swiss franc terms.
d. Reject the project but keep looking for positive-NPV projects in the British
pound due to favourable exchange rate forecasts in its real value against the
Swiss franc.
e. Reject the project. It is both a bad project and there are unfavourable
exchange rate forecasts.

The following information is used for the next THREE questions.

You work for a firm whose home currency is the Russian ruble (RUB) and that
is considering a foreign investment. The investment yields expected after-tax
Swedish krona (SEK) cash flows (in millions) as follows:

Year 0 Year 1 Year 2 Year 3

−SEK1,100 SEK750 SEK750 SEK750

Expected inflation is 4.0% in the Russian ruble and 34.0% in the Swedish krona.
Required returns for projects in this risk class are:

• iRUB = 18.8% in the Russian ruble; and

• iSEK = 36.5% in the Swedish krona

RUB/SEK
The spot exchange rate is S0 = RUB 6.3315/SEK.
Question 6

What is the NPV of the investment from the parent’s perspective?

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Question 7

What is the NPV of the investment from the project’s perspective?

Question 8

What is the correct course of action for the managers of the firm?

a. Accept the project and then, depending on the corporation’s tolerance for
risk, potentially leave the investment unhedged to take advantage of the
expected real appreciation of the project’s local currency (the Swedish krona)
against the parent company’s home currency (the Russian ruble).
b. Accept the project only if it is possible to hedge or otherwise structure
the deal to lock in the positive Swedish krona project value in the parent
company’s domestic Russian ruble terms.
c. Reject the project. It is both a bad project and there are unfavourable
exchange rate forecasts.
d. Accept the project and then hedge or otherwise capture the project’s value
if possible, as leaving the project unhedged is expected to reduce the magni-
tude of the positive NPV for the parent due to the forecast real depreciation
of the Swedish krona against the Russian ruble.
e. Reject the project but keep looking for positive-NPV projects in the Swedish
krona due to favourable exchange rate forecasts in its real value against the
Russian ruble.

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 FINS3616 Capital Budgeting Practice Problems

The following information is used for the next THREE questions.

You work for a firm whose home currency is the Japanese yen (JPY) and that is
considering a foreign investment. The investment yields expected after-tax Danish
krone (DKK) cash flows (in millions) as follows:

Year 0 Year 1 Year 2 Year 3

−DKK800 DKK475 DKK475 DKK475

Expected inflation is 7.0% in the Japanese yen and 24.0% in the Danish krone.
Required returns for projects in this risk class are:

• iJPY = 11.0% in the Japanese yen; and

• iDKK = 32.3% in the Danish krone

JPY/DKK
The spot exchange rate is S0 = JPY 20.239/DKK.
Question 9

What is the NPV of the investment from the parent’s perspective?

Question 10

What is the NPV of the investment from the project’s perspective?

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Question 11

What is the correct course of action for the managers of the firm?

a. Reject the project but keep looking for positive-NPV projects in the Danish
krone due to favourable exchange rate forecasts in its real value against the
Japanese yen.
b. Accept the project only if it is possible to hedge or otherwise structure
the deal to lock in the positive Danish krone project value in the parent
company’s domestic Japanese yen terms.
c. Accept the project and then hedge or otherwise capture the project’s value
if possible, as leaving the project unhedged is expected to reduce the magni-
tude of the positive NPV for the parent due to the forecast real depreciation
of the Danish krone against the Japanese yen.
d. Reject the project. It is both a bad project and there are unfavourable
exchange rate forecasts.
e. Accept the project and then, depending on the corporation’s tolerance for
risk, potentially leave the investment unhedged to take advantage of the
expected real appreciation of the project’s local currency (the Danish krone)
against the parent company’s home currency (the Japanese yen).

The following information is used for the next THREE questions.

You work for a firm whose home currency is the British pound (GBP) and that is
considering a foreign investment. The investment yields expected after-tax Swiss
franc (CHF) cash flows (in millions) as follows:

Year 0 Year 1 Year 2 Year 3

−CHF1,500 CHF700 CHF700 CHF700

Expected inflation is 15.0% in the British pound and 20.0% in the Swiss franc.
Required returns for projects in this risk class are:

• iGBP = 11.0% in the British pound; and

• iCHF = 11.7% in the Swiss franc

GBP/CHF
The spot exchange rate is S0 = GBP 0.7709/CHF.
Question 12

What is the NPV of the investment from the project’s perspective?

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Question 13

What is the NPV of the investment from the parent’s perspective?

Question 14

What is the correct course of action for the managers of the firm?

a. Accept the project only if it is possible to hedge or otherwise structure the

deal to lock in the positive Swiss franc project value in the parent company’s
domestic British pound terms.
b. Accept the project and then, depending on the corporation’s tolerance for
risk, potentially leave the investment unhedged to take advantage of the
expected real appreciation of the project’s local currency (the Swiss franc)
against the parent company’s home currency (the British pound).
c. Accept the project and then hedge or otherwise capture the project’s value
if possible, as leaving the project unhedged is expected to reduce the magni-
tude of the positive NPV for the parent due to the forecast real depreciation
of the Swiss franc against the British pound.
d. Reject the project but keep looking for positive-NPV projects in the Swiss
franc due to favourable exchange rate forecasts in its real value against the
British pound.
e. Reject the project. It is both a bad project and there are unfavourable
exchange rate forecasts.

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The following information is used for the next TWO questions.

You work for a firm whose home currency is the Brazilian real (BRL) and that is
considering a foreign investment. The investment yields expected after-tax United
States dollar (USD) cash flows (in millions) as follows:

Year 0 Year 1 Year 2 Year 3

−USD1,000 USD500 USD500 USD500

Expected inflation is 9.0% in the Brazilian real and 12.0% in the United States
dollar. Assume that the international parity conditions hold.
Required returns for projects in this risk class are:

• iBRL = 12.0% in Brazilian real; and

• iUSD = 15.083% in United States dollar

BRL/USD
The spot exchange rate is S0 = BRL 3.8458/USD.

The project country’s government has United States dollar-denominated bonds

outstanding that currently yield 6.09% per annum. Your firm pays a marginal
corporate tax rate of 25% on its United States dollar profits, which is the same
marginal tax rate that your firm pays on its parent company profits in Brazilian
real.

Question 15

Suppose that all of the United States dollar cash flows generated by the project
must be loaned to the country’s government at an interest rate of 0% per annum
for a period of exactly one year after they are generated by the project. Factoring
in the opportunity cost of the blocked funds, what is the NPV of the project?

Question 16

Suppose that all of the United States dollar cash flows generated by the project
must be loaned to the country’s government at an interest rate of 0% per annum
until one year after the completion of the project (i.e. until t=4). Factoring in the
opportunity cost of the blocked funds, what is the NPV of the project?

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The following information is used for the next ONE question only.
You work for a firm whose home currency is the Mexican peso (MXN) and that
is considering a foreign investment. The investment yields expected after-tax
Russian ruble (RUB) cash flows (in millions) as follows:

Year 0 Year 1 Year 2 Year 3

−RUB2,400 RUB1,125 RUB1,125 RUB1,125

Assume that Covered Interest Rate Parity holds and that your firm’s management
believes that Relative Purchasing Power Parity is the best way to predict future
exchange rates over this investment’s time horizon. You also have the following
information:

MXN RUB
Government bond yield 10.24% p.a. 17.52% p.a.
Expected inflation 5.00% p.a. 13.00% p.a.
Project required return 18.650% p.a. 27.690% p.a.

MXN/RUB
The spot exchange rate is S0 = MXN 0.2526/RUB.
Assume that your firm is unable to find a way to capture the project’s Russian
ruble value today through mechanisms such as securitizing the project and selling
the project to local investors.
Question 17

What is the gain in Mexican peso value that the parent company can expect to
receive by hedging the project’s cash flows using available forward rates as opposed
to leaving the investment unhedged?

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