DK Ltd. is considering an investment proposal in Sri Lanka involving an initial investment of LKR 25 billion. The current spot exchange rate is…

CA Final · Advanced Financial Management · MTP · May 2024
DK Ltd. is considering an investment proposal in Sri Lanka involving an initial investment of LKR 25 billion. The current spot exchange rate is INR/LKR 0.370. The risk free rate in India is 6% and the same in Sri Lanka is 5.02%. The project will generate a cash flow of LKR 5 billion in the first year. The cash flow will increase by LKR 1 billion each year for the next 4 years. The project will wind up on completion of 5 years with no salvage value. The required rate of return for the project is 8% (i) You are required to find out the investment worth of the project by using (1) Home Currency Approach (2) Foreign Currency Approach (ii) Compare the outcome under both the approaches. Given: PVIF (8%, t) 0.92593 0.85734 0.79383 0.73503 0.68058 PVIF (7%, t) 0.93457 0.87344 0.81630 0.76290 0.71299 Note: Excepts rates show all calculations in Billion upto four decimal points.

Suggested Answer and Working Notes:

Working Notes: Calculation of Forward Exchange Rates End of Year ₹/LKR 1 0.37 × (1.06 / 1.0502) = 0.373 2 0.373 × (1.06 / 1.0502) = 0.376 3 0.376 × (1.06 / 1.0502) = 0.380 4 0.380 × (1.06 / 1.0502) = 0.384 5 0.384 × (1.06 / 1.0502) = 0.388 1. Home Currency Approach Year Cash Flow Billion LKR ₹/LKR Cash flow Billion ₹ PVF @ 8% PV Billion ₹ 1 5 0.373 1.865 0.92593 1.7269 2 6 0.376 2.256 0.85734 1.9342 3 7 0.380 2.660 0.79383 2.1116 4 8 0.384 3.072 0.73503 2.2580 5 9 0.388 3.492 0.68058 2.3766 Total 10.4073 Less: Investment 25 0.37 9.2500 NPV 1.1573 Thus, Rupee NPV of the Project = 0.37 × 3.1477 = 1.1646 billion Decision: NPV is positive in the approach so, project will worth investment. 2. Foreign Currency Approach (1 + 0.06) (1+ Risk Premium) = 1.08 1 + Risk Premium = 1.08/1.06 = 1.01887 Therefore, Risk adjusted LKR Rate = 1.01887 × 1.0502 – 1 = 0.07 i.e. 7% Calculation of NPV Year Cash Flow (Billion LKR) PVF @ 7% PV (Billion LKR) 1 5 0.93457 4.6729 2 6 0.87344 5.2406 3 7 0.81630 5.7141 4 8 0.76290 6.1032 5 9 0.71299 6.4169 Total 28.1477 Less: Investment 25.0000 NPV 3.1477 Thus, Rupee NPV of the Project = 0.37 × 3.1477 = 1.1646 billion Decision: NPV is positive in the approach so, project will worth investment.

Topics: International Financial Management

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