NPV

Cash Flows:

Year 0 1 2 3
Investment –9
Operating CF 3 3 2
Note:
The exchange rate for each
Salvage Value 5
period (F) is calculated from
the previous period spot rate Net CF (cedi billions) –9 3 3 7
(S) using:
(F-S)/S = x%
Exchange rate 8,700 9,135 9,592 10,071
However, be careful that this Cash flows to parent –$1,034,483 $328,407.23 $312,760.63 $695,065.04
formula gives you x% as the
appreciation/ depreciation of PV of parent cash flows –$1,034,483 $280,689.94 $228,475.88 $433,978.15
the base currency.
In this question you are given
NPV Just the cumulative sum –$1,034,483 –$753,793.06 –$525,317.18 –$91,339.03
the term currency depreciation. of PVs at each date
The theoretically correct way
is to take the reciprocal Since the project has a negative net present value (NPV), Brower should not undertake it.
exchange rate (since no
bid/ask spread) then apply this
formula (see assignment 1).
Alternatively you can use the
other formula for term
currency appreciation. ANSWER: b
However, in this model answer
it looks like they simply
assumed that 5% depreciation
of cedi (term) means a 5% If the cedi was expected to remain unchanged from its current value of 8700 cedis per
appreciation of US$ (base),
then they applied the base
currency formula!
U.S. dollar over the course of the three years:

Year 0 1 2 3
Investment –9
Operating CF 3 3 2
Salvage Value 5
Net CF (cedi billions) –9 3 3 7
Exchange rate 8,700 8,700 8,700 8,700
Cash flows to parent –$1,034,483 $344,827.59 $344,827.59 $804,597.70
PV of parent cash flows –$1,034,483 $294,724.44 $251,901.23 $502,367.11
NPV –$1,034,483 –$739,748.56 –$487,847.33 +$14,519.78

If the value of the cedi remains constant, the NPV is positive. Thus, Brower should
undertake the project in this case. Of course, the NPV is only slightly positive. Whether
or not Brower actually undertakes the project depends on the confidence it has in its
exchange rate forecasts.