Question 1. International Investment Decisions.
Carpet Baggers Inc. is proposing to construct a new bagging plant in a country in Europe. The two prime candidates are Germany and Switzerland. The forecast cash flows from the proposed plants are as follows:
The spot exchange rate for euros is USD1.3 = EUR1, while the rate for Swiss francs is CHF1.5 = USD1. The interest rate is 5% in the United States, 4% in Switzerland, and 6% in the euro countries. The financial manager has suggested that if the cash flows were stated in dollars, a return in excess of 10% would be acceptable.
a. What is the dollar NPV of the German project?
b. What is the dollar NPV of the Swiss project?
c. Should the company go ahead with the German project, the Swiss project, or neither?
Question 2. Exchange Rate Risk.
General Gadget Corp. (GGC) is a U.S.-based multinational firm that makes electrical coconut scrapers. These gadgets are made only in the United States using local inputs. The scrapers are sold mainly to Asian and West Indian countries where coconuts are grown.
a. If GGC sells scrapers in Trinidad, what is the currency risk faced by the firm?
b. In what currency should GGC borrow funds to pay for its investment in order to mitigate its foreign exchange exposure?
c. Suppose that GGC begins manufacturing its products in Trinidad using local (Trinidadian) inputs and labor. How does this affect its exchange rate risk?