Reference no: EM132005672

Dynasty Co. is considering the acquisition of a unit from the French government. Its initial outlay would be $5 million. It will reinvest all the earnings in the unit. It expects that at the end of 8 years, it will sell the unit for 13,200,000 euros after capital gains taxes are paid. The spot rate of the euro is $1.20 and is used as the forecast of the euro in the future years. The annualized U.S. risk-free interest rate is 0.05 regardless of the maturity of the debt, and the annualized risk-free interest rate on euros is 0.07, regardless of the maturity of debt. Assume that interest rate parity exists. Dynasty's cost of capital is 20%. Dynasty could partially finance the acquisition. It could obtain a loan of 3 million euros today that would be used to cover a portion of the acquisition. In this case, it would have to pay back a lump sum total of 7 million euros at the end of 8 years to repay the loan. There are no interest payments on this debt. The way in which this financing deal is structured, none of the payment is tax-deductible. Determine the NPV if Cantoon uses the forward rate instead of the spot rate to forecast the future spot rate of the euro, and elects to partially finance the acquisition. [You need to derive the 8-year forward rate for this specific question.]

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