Question - PKOF considers bidding for a big dredging project in the port of Lagos. The project would yield annual cash flows of 2.5 billion NGN for the next three years. At the current exchange rate of NGN 125/EUR, this corresponds to an annual cash flow of EUR 20 million. Inflation in Nigeria and in the euro area are currently 7% and 1%, respectively. For projects in EUR, PKOF normally uses a discount rate of 10%. PKOF estimates costs for this project to amount to EUR 40 million (in present value terms).
Calculate the Net Present Value of this project both by (a) making discount rate adjustments, or (b) by using expected future exchange rates. Assume for the time being a zero country risk premium.
Clearly, given the location, this project has political risk.