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You are a U.S. investor who is trying to calculate the present value of a ∊ [&|euroSer|&]5 million
- a. What is the present value of the ∊[&|euroSer|&]5 million cash inflow computed by first discounting the euro and then converting it into dollars?
- b. What is the present value of the ∊[& |euroSer| &] 5 million cash inflow computed by first converting the cash flow into dollars and then discounting?
- c. What can you conclude about whether these markets are internationally integrated, based on your answers to parts a and b?
a.
To determine: The present value of the cash inflow computed by first discounting the euro and then converting it into dollars.
Introduction: The present value is an amount that an individual makes as an investment at present in order to generate the cash flow in the future. The present value of the cash flows can be computed by adding the cash flow of every stream.
Answer to Problem 1P
Explanation of Solution
The given information:
Cash inflow: €5,000,000.
Spot exchange rate: $1.25/€
Forward rate
Dollar discounted cash flow rate: 4.00%
Euro discount rate: 7.00%.
The formula for calculating the present value by first discounting the euro and then converting it into dollars is as follows:
Calculation of the present value of the cash inflow computed by first discounting the euro and then converting it into dollars is as follows:
For converting it into the dollar, multiply the present value by spot exchange rate as shown below:
Therefore, the present value of the cash inflow is $5,841,121.50.
b.
To determine: The present value of the cash inflow computed by first converting the cash flow into dollars and then discounting.
Answer to Problem 1P
Explanation of Solution
Given information:
Cash inflow: €5,000,000.
Spot exchange rate: $1.25/€
Forward rate
Dollar discounted cash flow rate: 4.00%
Euro discount rate: 7.00%.
The formula for calculating the present value by first converting into cash flow, then into the dollar, and discounting is as follows:
Calculation of the present value of the cash inflow computed by first converting into cash flow, then into dollar, and discounting is as follows:
For converting the cash flow into the dollar, multiply the cash flow by forward rate as shown below:
Therefore, the present value of the cash inflow is $5,841,346.15.
c.
To determine: Whether the markets are internationally integrated, basic of part A and part B.
Answer to Problem 1P
Answer: Yes, the markets are internationally integrated, basic of part A and part B.
Explanation of Solution
Yes, the markets are internationally integrated, basic of part A and part B because, the present value of the cash inflow in part A and part B is approximately identical to each other.
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Chapter 31 Solutions
Corporate Finance (4th Edition) (Pearson Series in Finance) - Standalone book
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