You are evaluating a proposed expansion of an existing subsidiary located in Switzerland. The cost of the expansion would be SF 15 million. The cash flows from the project would be SF 4.4 million per year for the next five years. The dollar required return is 15 percent per year, and the current exchange rate is SF 1.09. The going rate on Eurodollars is 5 percent per year. It is 4 percent per year on Euroswiss. Use the approximate form of interest rate parity in calculating the expected spot rates.

Question

Carly Choi

Business

17 March, 22:10

You are evaluating a proposed expansion of an existing subsidiary located in Switzerland. The cost of the expansion would be SF 15 million. The cash flows from the project would be SF 4.4 million per year for the next five years. The dollar required return is 15 percent per year, and the current exchange rate is SF 1.09. The going rate on Eurodollars is 5 percent per year. It is 4 percent per year on Euroswiss. Use the approximate form of interest rate parity in calculating the expected spot rates.

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Answers (2)

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Julianna Andersen · Answer 1

SF7.37

Explanation:

PV of cash flow is calculated using the formula

1 - (1+r) ^-n/r=1 - (1-0.15) ^5/0.15=1 - (0.75) ^5/0.15=1-0.237/0.15=5.085

So pv=5.085*4.4=SF

20.3385million

Using interest parity

1+ic/1+ib = Fo/So

Counter country is US while home country is in

swiss

1+0.05/1.04=fo/1.09

Fo=1.09*1.05/1.04=1.1

So expected PV=20.3385*1.1=SF22.37235million

Profit=23.37235-15=SF7.37

Ruby Gardner · Answer 2

1.1434

Explanation:

To calculate the future spot rates we will use the Interest rate parity

E (S) = S0 * (Fr/Dr) ^t

year 1=109 * (1.05/1.04) ^1=1.1005

=1.09 (1.05/1.04) ^2=1.1111

=1.09 (1.05/1.04) ^3=1.1217

=1.09 (1.05/1.04) ^4=1.1325

=1.09 (1.05/1.04) ^5=1.1434