The Wheel Deal Inc., a company that produces scooters and other wheeled non-motorized recreational equipment is considering an expansion of their product line to Europe. The expansion would require a purchase of equipment with a price of euro 1,200,000 and additional installation of euro 300,000. The new product line is expected to increase net revenues by euro 300,000 for the next 10 years. The equipment is multipurpose and the firm anticipates that they will sell it at the end of the 10th year for euro 500,000. The initial investment (at year 0) also requires an increase in Net Working Capital of euro 100,000 (to be recovered at the end of 10th year). The current spot rate is $0.95/euro, and the expected inflation rate in the U.S. is 2% per year and 5% per year in Europe.
Use Spreadsheet to carry out the following calculations (show your formulas in each cell):
i. Based on the relative version of purchasing power parity relationship, calculate the expected appreciation/depreciation in euro and forecast the expected exchange rate for the next 10 years.
ii. Develop the timeline of cash flows (years 0 – 10) in euros
iii. Use the spot exchange rate and your forecasted exchange rate to calculate the timeline of future cash flows (years 0-10) in dollar terms.
iv. Compute the IRR of the project
v. Compute the NPV of the project at discount rates of (a) 8% (b) 9% (c) 11% (d) 12%.
vi. Plot in graph (you can use scatter with smooth lines option) the Net Present Values at above mentioned discount rates and show the IRR in the graph.
vii. Based on IRR and NPV calculations, comment if the project is acceptable or not at the above discount rates.
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