Question 8.6: The Eurozone firm DYA will generate uncertain future operati...

The Eurozone firm DYA will generate uncertain future operating cash flows in euros for 5 years, expected to be €1 million per year. XYZ Company, a U.S. firm, is considering the acquisition of DYA. XYZ estimates that from the U.S. dollar perspective, DYA’s FX operating exposure to the euro is \underline{1.50} 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, \underline{the \ volatility \ of \ the \ euro \ is \ 0.10} , and the time-0 intrinsic and actual spot FX rates are 1.50 $/€ and 1.80 $/€, respectively. Assume the global CAPM RA-UIRP condition applies, and GRP^\$ is 5%. XYZ forecasts that the spot FX rate will gradually converge to the expected 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 8.2. (c) Find DYA’s intrinsic business value in U.S. dollars.

Exhibit 8.2. Five-Year Project Scenario (Short-Cut)