Question: NPV and financing. Louisville Co. is a U.S. firm considering a project in Austria which it has an initial cash outlay of $7 million. Louisville will accept the project only if it can satisfy its required rate of return of 18 percent. The project would definitely generate 2 million euros in one year from sales to a large corporation customer in Austria. In addition, it also expects to receive 4 million euros in one year from sales to other customers in Austria. Louisville's best guess is that the euro's spot rate will be $1.26 in one year. Today, the spot rate of the euro is $1.40, while the one-year forward rate of the euro is $1.34. If Louisville accepts the project, it would hedge all the receivables resulting from sales to the large corporate customers but none of the expected receivables due to expected sales to other customers.
a. Estimate the net present value of the project.
b. Assume that Louisville considers alternative financing from the project in which it would use $5 million cash while the remaining initial layout would come from borrowing euros. In this case, it would need 1,600,000 euros to repay the loan ( principlal plus interest) at the end of year one. Assume no tax effects due to the althernative financing. Estimate the NPV of the project under these conditions.
c. Do you think the Louisville's exposure to exchange rate risk due to the project if it uses the althernative financing (explained in part b) is higher, lower or the same as if it has an initial cash outlay of $7 million (and does not borrow any fund)? Briefly explain.