PQR Ltd. is considering a project in US, which involve an initial investment of 124.50 Crore. The project will have useful life of 5 years Current…

CA Final · Advanced Financial Management · PYQS · November 2024
PQR Ltd. is considering a project in US, which involve an initial investment of 124.50 Crore. The project will have useful life of 5 years Current spot exchange rate is INR/USD is 83. The risk free rate in US is 4.186% and the same in India is 6.9768%. Cash inflows in USD from the project are as follows: Year 1 2 3 4 5 Cash inflow 30,00,000 40,00,000 50,00,000 60,00,000 70,00,000 PQR Ltd. is expecting net surplus of 1858.08 lakh to be received after closure of the project. There is no salvage value. PQR Ltd. want to take a forward cover to protect itself from exchange rate fluctuations. N 1 2 3 4 5 PVIF (6.976%, n) 0.935 0.874 0.817 0.764 0.714 PVIF (4.186%, n) 0.959 0.921 0.884 0.849 0.815 PVIF (12%, n) 0.893 0.797 0.712 0.636 0.567 PVIF (15%, n) 0.870 0.756 0.658 0.572 0.497 You are required to recommend the INR/USD rate for the forward cover?

Suggested Answer and Working Notes:

Let F be the recommended INR/USD rate for the forward cover. Accordingly, year-wise equivalent cash inflows in Indian Rupees shall be as follows: Year Cash Inflow in USD Lakh Cash Inflow in ₹ Lakh 1 30.00 30.00F 2 40.00 40.00F 3 50.00 50.00F 4 60.00 60.00F 5 70.00 70.00F Now let us compute Net Present Value of project assuming a discount rate of 12% as follows: Year PVF@12% Cash flow in ₹ Lakh PV in ₹ Lakh 0 1.00 - 12450.00 - 12450.00 1 0.893 30.00F 26.79F 2 0.797 40.00F 31.88F 3 0.712 50.00F 35.60F 4 0.636 60.00F 38.16F 5 0.567 70.00F 39.69F 172.12F - 12450 Since expected surplus after closure of the project is 1858.08 Lakh, we can compute the value of F as follows: 1858.08 = 172.12F - 12450 F = 83.13 Thus, for forward cover the rate of 83.13/ USD is recommended. Alternatively, if students have assumed discounting rate as 15% then answer will be as follows: Let F be the recommended INR/USD rate for the forward cover. Accordingly, year-wise equivalent cash inflows in Indian Rupees shall be as follows: Year Cash Inflow in USD Lakh Cash Inflow in ₹ Lakh 1 30.00 30.00F 2 40.00 40.00F 3 50.00 50.00F 4 60.00 60.00F 5 70.00 70.00F Now let us compute Net Present Value of project assuming a discount rate of 15% as follows: Year PVF@15% Cash flow in ₹ Lakh PV in ₹ Lakh 0 1.00 - 12450.00 - 12450.00 1 0.870 30.00F 26.10F 2 0.756 40.00F 30.24F 3 0.658 50.00F 32.90F 4 0.572 60.00F 34.32F 5 0.497 70.00F 34.79F 158.35F - 12450 Since expected surplus after closure of the project is 1858.08 Lakh, we can compute the value of F as follows: 1858.08 = 158.35F - 12450 F = 90.36 Thus, for forward cover the rate of 90.36/ USD is recommended. Alternative Solution if students have assumed the discounting rate 15% for the given cash inflows then applicable discounting rates for the project is - (1 + 0.06978) / (1 + Risk Premium) = (1 + 0.15) Or, 1 + Risk Premium = 1.15/1.06978 = 1.0750 Therefore, Risk adjusted dollar rate is = (1.0750 x 1.04186) -1 = 1.1199 – 1 = 0.12 Calculation of NPV Year Cash flow US$ lakh PV Factor at 12% PV (US$ lakh) 1 30.00 0.893 26.79 2 40.00 0.797 31.88 3 50.00 0.712 35.60 4 60.00 0.636 38.16 5 70.00 0.567 39.69 172.12 Less: Investment 150.00 NPV 22.12 Since PQR Ltd. is expecting a net surplus of 1858.08 lakh after the closure of the project the recommended rate of INR/ USD is (₹ 1858.08 lakh/ USD 22.12 lakh) ₹ 84.00.

Topics: Foreign Exchange Exposure and Risk Management

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