Assume that management is considering whether to make the foreign direct investment described in Exercise 3. Investment will require $6,000,000 in equity capital. Cash flows to the parent are expected to increase by 5 percent over the previous year for each year after year 2 (through year 6). Exchange rate forecasts are as follows:
|
Year |
Rate |
|
1 |
RUB 26 = $1 |
|
2 |
RUB 27 = $1 |
|
3 |
RUB 29 = $1 |
|
4–6 |
RUB 31 = $1 |
Management insists on a risk premium of 10 percent when evaluating foreign projects.
Required: Assuming a weighted average cost of capital of 10 percent and no expected changes in differential tax rates, evaluate the desirability of the Russian investment using a traditional discounted cash flow analysis.