A year ago, the spot exchange rate of the euro was $1.20. At that time, Talen Co. (a U.S. firm) invested $4 million to establish a project in the Netherlands. It expected that this project would generate cash flows of 3 million euros at the end of the first and second years.
Talen Co. always uses the spot rate as its forecast of future exchange rates. It uses a required rate of return of 20 percent on international projects.
Because conditions in the Netherlands are weaker than expected, the cash flows in the first year of the project were 2 million euros, and Talen now believes the expected cash flows for next year will be 1 million euros. A company offers to buy the project from Talen today for $1.25 million. Assume no tax effects. Today, the spot rate of the euro is $1.30. Should Talen accept the offer? Show your work.
As of today, the NPV from selling the project is:
Proceeds received from selling the project – Present value of the forgone cash flows.
Proceeds $1.25 million.
PV of forgone cash flows = (1,000,000 × $1.30)/1.2 = $1,083,333.
The NPV from selling the project is $1,250,000 – $1,083,333 = $166,667
Therefore, selling the project is feasible.