Convert the pound cash flows to dollars at the expected

Reference no: EM13477199

The (annualized) interest rate on six-month treasuries is 5% in the U.S. and 8% in Great Britain. Inflation is expected to run at a constant 3% in the U.S. and at a constant 6% in Great Britain for the next ten years. The spot exchange rate is 1.94 $/£ and the 180-day forward rate is 1.90 $/£. You work for an American Company that has a subsidiary in Great Britain. Your company uses a WACC of 14% to evaluate projects of this sort. The subsidiary in Great Britain is considering an expansion that will cost £7 million, but will generate an additional £3 million of revenue per year for five years. The cost of the expansion can be depreciated on a straight-line basis over the five years and will have no salvage value. The applicable tax rate is 35%.

Convert the pound cash flows to dollars at the expected future spot rates by assuming that Relative Purchasing Power Parity will hold. Discount the cash flows and calculate the NPV in dollars.

Reference no: EM13477199

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