 ## What would you estimate is the diffe

a.       What would you estimate is the difference between the annual inflation rates of the United States and Japan?

1.       Expected Spot Rates [LO2] Suppose the spot exchange rate for the Hungarian forint is HUF 204.32. The inflation rate in the United States will be 1.9 percent per year. It will be 4.5 percent in Hungary. What do you predict the exchange rate will be in one year? In two years? In five years? What relationship are you using?

2.       Capital Budgeting [LO2] Lakonishok Equipment has an investment opportunity in Europe. The project costs €12 million and is expected to produce cash flows of €1.8 million in Year 1, €2.6 million in Year 2, and €3.5 million in Year 3. The current spot exchange rate is \$1.36/€ ;the current risk-free rate in the United States is 2.3 percent, compared to that in Europe of 1.8 percent. The appropriate discount rate for the project is estimated to be 13 percent, the U.S cost of capital for the company. In addition, the subsidiary can be sold at the end of three years for an estimated €8.9 million. What is the NPV of the project?

3.       Capital Budgeting [LO2] You are evaluating a proposed expansion of an existing subsidiary locatd in Switerzland. The cost of the expansion would be SF 21 million. The cash flows from the project would be SF 5.9 million per year for the next five years. The dollar required return is 12 percent per year, and the current exchange rate is SF 1.09. The going rate on Eurodollars is 5% per year. It is 4% per year on Eurowiss.

a.       What do you project will happen to exchange rates over the next four years?

b.       Based on your answer in (a), convert the projected franc flows into dollars flows and calculate the NPV.

c.        What is the required return on franc flows? Base on your answer, calculate the NPV in francs and then convert to dollars.

4.       Translation Exposure [LO3] Atreides International has operations in Arrakis. The balance sheet for this division in Arrakeensolaris shows assets of 27,000 solaris, debt in the amount of 11,000 solaris, and equity of 16,000 solaris.

a.       If the current exchange ratio is 1.50 solaris per dollar, what does the balance sheet look like in dollars?

b.       Assume that one year from now the balance sheet in solaris is exactly the same as at the beginning of the year. If the exchange rate is 1.60 solaris per dollar, what does the balance sheet look like in dollars now?

c.        Rework part (c) assuming the exchange rate is 1.41 solaris per dollar.

5.       Translation Exposure [LO3] In the previous problem, assume the equity increases by 1,250 solaris due to retained earnings. If the exchange rate at the end of the year is 1.54 solaris per dollar, what does the balance sheet look like?

6.       Using the Exact International Fischer Effect [LO2] From or discussion of the Fischer effect in Chapter 7, we know that the actual relationship between a nominal rate, R, a real rate, r, and an inflation rate, h, can be written as:

1 + r = (1 + R)/(1 + h)

This is the domestic Fischer effect.

a.       What is the nonapproximate form of the international Fischer effect?

b.       Based on your answer in (a), what is the exact form for UIP? (Hint: Recall the exact form of IRP and use UFR)

c.        What is the exact form for relative PPP? (Hint: Combine your previous two answers.)

d.       Recalculate the NPV for the Kihlstrom drill bit project (discussed in Section 21.5) using the exact forms for UIP and the international Fischer effect. Verify that you get precisely the same answer either way.

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20 Mar 2018
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