Study Questions
1. Compute the net present value of the photoelectric inspection equipment in: a.) pesetas, by discounting peseta cash flows at a peseta discount rate; and b.) dollars, by translating future peseta cash flows into dollars at expected future spot exchange rates. Assume that at the time of the analysis, annual inflation was expected to be 8% in Spain and 4% in the United States.
2. How and why do these two net present values differ? Which analytic approach should Merck use to evaluate this project? Why?
3. How sensitive is the NPV of the new equipment to changes in the peseta/dollar exchange rate? What happens to the NPV if Spanish inflation is assumed to be less than 8% per year (assume that expected dollar inflation remains at 4% per year)?
4. Assume the conditions in paragraph 3 continue. What would happen if, in year zero the exchange rate was 127 Pts / USD; in the first year the exchange rate was 150 Pts / U $; and in the second year onwards the exchange rate was 170 Pts / U $ ?.
5. Should Merck headquarters approve the equipment purchase?
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