Investment Analysis: NPV, Forward Rate, and Financial Planning

This assignment solution delves into the core concepts of financial planning, specifically focusing on Net Present Value (NPV) and forward rate calculations. It demonstrates how to calculate NPV, considering both cash inflows and outflows, and explains the significance of the discount rate. The solution also addresses the complexities of international finance, illustrating the calculation of forward rates for currency conversion, particularly for a multinational company operating in Switzerland and the United States. The assignment highlights how these calculations impact investment decisions and shareholder wealth, providing a clear understanding of financial analysis in a global context. The solution uses a case study approach to explain the calculations, along with the references to support the methodology.

Solution 19-17
a. Net present value refers to the value which comes after adding all cash inflows and
subtracting all cash out flows at their present value (Remer & Nieto 1995). The present
value under this method of calculating net present value, calculated by discounting all
cash inflows and outflows at the risk adjusted cost of capital. Positive net present value of
any project denotes that project will enhance the wealth of shareholders of the
organization on the other hand acceptance of a project having a negative net present value
of any project concludes the destruction of shareholder’s wealth.
In the present case, a US based company is going to make an investment in the financial
plan for a year. This project needs $1000 in the starting of the first year and earns $1200
at the end of the year. Discounting rate i.e. risk adjusted cost of capital is 12%.
Net present value for this project can be calculated in this way
Net present value = -Present value of cash outflow + Present value of cash inflow
Net present value = -1000+ 1200/ (1.12)
Net present value = -1000+ 1072.43
Net present value = $71.43
Therefore if the company is established in the US and does not need to make the foreign
exchange from the project then the net present value of the project in consideration is
$71.43. It also concludes that this project will increase the wealth of shareholders of the
organization.
b. In the present scenario, organizations cross the countries of the country. Hence
organizations need to trade between currencies of various countries. A currency of a
country can be converted to the currency of another country on the same day by using the
spot rate of converting that currency in the other currency. However, sometimes
organizations need to know regarding the currency conversion rate for any future date.
This currency conversion rate is known as a forward rate (Fama 1984). The forward rate
can be calculated by using the spot rate of the home currency and the risk free yield rate
of securities in both countries.
In the present case, Solitaire Machinery is a multinational company situated in the
Switzerland and doing business by using Swiss franc as money. The company is seeking
for the financial plan for a year in the United States. This financial plan will need to
invest US dollars in the United States earn in US dollar for the year thereafter convert
that earning in the Swiss franc at the end of one year. Net earnings from this process in
the Swiss franc can be calculated by the company by making calculations regarding the
one year forward rate of converting US dollars in to the Swiss franc. This calculation can
be made in this way,
Forward rate = Spot rate of home currency * (1+ yield rate in Foreign country) / (1+ yield
rate in home country)
Forward rate = 0.9* 1.05 /1.0325

Forward rate = .915
c. Net present value is a difference between the sum of cash inflows and cash outflows at
the present value of those cash flows. Present value calculations are done by discounting
cash flows at the cost of capital rate of the organization for that period of time. Positive
net present value means the present value of cash inflows is higher than the present value
of cash outflows. However negative net present value denotes that present value of cash
outflows is higher than the present value of cash inflows (Ross et al. 2013).
In the present case, Solitaire Machinery is a multinational company situated in the
Switzerland and doing business by using Swiss franc as money. The company is seeking
for the financial plan for a year in the United States. This financial plan will need to
invest US dollars in the United States earn in US dollar for the year thereafter convert
that earning in the Swiss franc at the end of one year. Net present value for this project
can be calculated in this way
Net present value = -Present value of cash outflow in Sfr + Present value of cash inflow
in Sfr
Net present value = -1000 * 0.9 + 1200 * 0.915 / (1.12)
Net present value = -900+ 980.36
Net present value = Sfr80.36
Therefore if the company is established in the US and does need to make the foreign
exchange from the project then the net present value of the project in consideration is
Sfr80.36. It also concludes that this project will increase the wealth of shareholders of the
organization.

Works Cited
Fama, E 1984, 'Forward and spot exchange rates', Journal of monetary economics, vol 14, no. 3,
pp. 319-338.
Remer, D & Nieto, A 1995, 'A compendium and comparison of 25 project evaluation techniques.
Part 1: Net present value and rate of return methods', International Journal of Production
Economics, vol 42, no. 1, pp. 79-96.
Ross, S, Westerfield, R, Jaffe, J & Roberts, G 2013, Corporate finance, 10th edn, Irwin and
McGraw-Hill.