Problem:
Omega Industries, a U.S MNC, is contemplating making a foreign capital expenditure in SA. The initial cost of the project is ZAE10000. The annual cash flows over the five year economic life of the project in ZAR are estimated to be 3000, 4000, 5000, 6000 and 7000. The parent firm's cost of capital in dollars is 9.5 percent. Long run inflation is forecasted to be 3 percent per annum in the U.S and 7 percent in SA. The current spot foreign exchange rate is ZAR/USD = 3.75. Determine the NPV for the project in USD by:
Required:
Question 1: Calculating the NPV in ZAR using the ZAR equivalent cost of capital according to the Fischer Effect and the converting to USD at the current spot rate
Question 2: Converting all cash flows from ZAR to USD at purchasing power parity forecast exchange rates and then calculting the NPV at the dollar cost of capital.
Question 3: What is the NPV in dollars if the actual pattern of ZAR/USD exchange rate is: S(0) = 3.75, S(1) = 5.7, S(2) = 6.7, S(3) = 7.2, S(4) = 7.7, and S(5) = 8.2?
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