Question 8.5: The Eurozone firm DYA expects €1 million per year in operati...
The Eurozone firm DYA expects €1 million per year in operating cash flow for 5 years. XYZ Company, a U.S. firm, is considering acquiring DYA. XYZ estimates that in U.S. dollars, DYA’s FX operating exposure to the euro is 1 and the cost of capital is 8.50%. Assume {r_f}^\$ = 3\% \ and \ {r_f}^€ = 6\% , the currency beta of the euro is 0.20, the time-0 actual and intrinsic spot FX rates are 1.80 $/€ and 1.50 $/€, the global CAPM RA-UIRP condition applies, and GRP^\$ is 5%. XYZ forecasts that the spot FX rate will gradually converge to the intrinsic spot FX rate by year 5, as follows: E({X_1}^{\$/€}) = 1.70 \ \$/€; \ E({X_2}^{\$/€}) = 1.60 \ \$/€; \ E({X_3}^{\$/€}) = 1.50 \ \$/€; \ E({X_4}^{\$/€}) = 1.40 \ \$/€ . (a) Find DYA’s intrinsic business value in euros. (b) Make a table in the format of Exhibit 8.1. (c) Find DYA’s intrinsic business value in U.S. dollars.
Exhibit 8.1. Five-Year Project Scenario
N | E^*({X_N}^{\$/€}) | E({X_N}^{\$/€}) | E^*({O_N}^\$) | E({O_N}^\$) | E({O_N}^\$)- E^*({O_N}^\$) |
1 | 0.985 $/€ | 0.90 $/€ | $1,970 | $1,800 | –$170 |
2 | 0.970 $/€ | 0.91 $/€ | $1,940 | $1,820 | –$120 |
3 | 0.956 $/€ | 0.92 $/€ | $1,912 | $1,840 | –$72 |
4 | 0.941 $/€ | 0.93 $/€ | $1,882 | $1,860 | –$22 |
5 | 0.927 $/€ | 0.927 $/€ | $1,854 | $1,854 |
Our explanations are based on the best information we have, but they may not always be right or fit every situation.
Learn more on how we answer questions.
