Wilmington Inc. is considering the acquisition of a unit from the French government.
• Initial outlay will be $4 million dollars
• All earnings reinvested
• Time period 8 years and at that time will sell acquisition for 12 million euros after taxes
• Spot rate for euro is $1.20
• Risk free U.S. intersect rate regardless of maturity is 5 percent
• Risk free interest rate on euros regardless of maturity is 7 percent
• Interest rate parity holds
• Cost of capital is 20 percent
• Cash will be used for acquisition
a. Using the parameters above, Determine the NPV.
b. Rather than use all cash, Wilmington Inc. could partially finance the acquisition. It could obtain a loan of 3 million euros today that would be used to cover a portion of the acquisition. In this case, it would have to pay back a lump sum total of 7 million euros at the end of 8 years to repay the loan. There are no interest payments on this debt. This financing deal is structured such that none of the payment is tax-deductible. Determine the NPV if Wilmington uses the forward rate instead of the spot rate to forecast the future spot rate of the euro, and elects to partially finance the acquisition.