1. A US firm is evaluating a 3-year capital budgeting project in Japan. The initial cost of the project is 100 million yen. The project is expected togenerate 50 million yen per year over the next 3 years. The exchange rate is $1 = 95 yen and it is expected to be constant over time. The firm conducts country risk assessment and finds two scenarios as follows.
Scenario 1: 70% chance that the Japanese government imposes 20% tax on annual cash flows generated by the project.
Scenario 2: 30% chance that the Japanese government imposes 10% tax on annual cash flows generated by the project.
The firm estimates a discount rate of 10% for the project. Find the expected NPV of the project.
2. A US firm has a European branch in Germany and analyzes its cash flows in euro. Use the following exchange rate information to find the standard deviation of the euro movement.
12/31/2009: 1 euro = $1.16
12/31/2010: 1 euro = $1.21
12/31/2011: 1 euro = $1.19
12/31/2012: 1 euro = $1.24 (Today’s spot rate)
The annual US interest rate is 3% and the annual euro interest rate is 5%. Assuming that the IRP holds and the firm uses the forward rate to forecast the next year’s exchange rate, find the maximum 1-year percentage loss of the euro using the value-at-risk method and a 99% probability. Use the following normal distribution.
z = -1.65 => Probability = .05
z= -1.96 => Probability = .025
z= -2.33 => Probability = .01
3.A US Co will need to pay 6 million euros to Bagano Co in 3 years and use the forward contract to hedge against the exchange rate risk. The annual US interest rate is 4.5% and the annual euro interest rate is 2%. If the IRP holds, what is the amount of US dollars the US Co will need to make the payment in 3 years? Assume that the spot rate of the euro is $1.22.
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