A U.S.-based firm is planning to make an investment in Europe. The firm estimates that the project will generate cash flows of 200,000 euros after one year. If the one-year forward exchange rate is $1.40/euro and the dollar cost of capital is 9%, what is the present value (PV) of the project cash cash flows
To calculate the present value (PV) of the project cash flows, we need to convert the future cash flows in euros into dollars and then discount them back to present value using the dollar cost of capital.
Step 1: Convert the cash flows from euros to dollars.
The cash flows are estimated to be 200,000 euros. Since the one-year forward exchange rate is $1.40/euro, we can calculate the cash flows in dollars:
Cash flows in dollars = Cash flows in euros * Exchange rate
= 200,000 euros * $1.40/euro
= $280,000
Step 2: Calculate the present value of the cash flows.
Now that we have the cash flows in dollars, we can calculate the present value using the dollar cost of capital. The dollar cost of capital is given as 9%.
PV = Cash flows / (1 + r)^n
Where:
PV = Present value
Cash flows = Cash flows in dollars
r = Dollar cost of capital
n = Number of years
In this case, as the cash flows are estimated for one year, n = 1.
PV = $280,000 / (1 + 0.09)^1
= $280,000 / 1.09
≈ $256,880.73
Therefore, the present value (PV) of the project's cash flows is approximately $256,880.73.