606 Brooks ◼ Financial Management: Core Concepts, 4e
21. Foreign currency NPV approach. Verify your answer to Problem 19 using the foreign
currency approach.
ANSWER
Foreign discount rate:
22. Foreign currency NPV approach. Verify your answer to Problem 20 using the foreign
currency approach.
ANSWER
Foreign discount rate:
Chapter 18 ◼ International Financial Management 607
Solutions to Advanced Problems for Spreadsheet Application
1. Find the triangular arbitrage across six currencies (three way pairs).
Jap ¥ 0.0000 0.0000 0.0000 0.0000 0.0000 0.0000 — 0.0000
Pound £ 0.0000 0.0000 0.0000 0.0000 0.0000 0.0000 0.0000 —
U.S. $ 1,000.00$
Triangular Arbitrage
Currency Rates
Given from Problem
U.S. $ CAN $ Peso Euro € HK $ Aus $ JAP ¥ Pound £
U.S. $ — 1.3333 16.0000 0.7407 6.4725 1.4545 98.0392 0.6466
CAN $ 0.7500 — 12.0000 0.5556 4.8544 1.0909 73.5294 0.4850
Peso 0.0625 0.0833 — 0.0463 0.4045 0.0909 6.1275 0.0404
Euro € 1.3500 1.8000 21.6000 — 8.7379 1.964 132.353 0.8729
HK $ 0.1545 0.2060 2.4720 0.1144 — 0.225 15.1471 0.0999
AUS $ 0.6875 0.9167 14.0000 0.5093 4.4498 — 67.4020 0.4466
Jap ¥ 0.0102 0.0136 0.1632 0.0076 0.0660 0.0148 — 0.0066
Pound £ 1.5465 2.0620 24.7440 1.1456 10.0097 2.2495 151.6176 —
Calculated Cross Rates
U.S. $ CAN $ Peso Euro € HK $ Aus $ JAP ¥ Pound £
U.S. $ — 1.3333 16.0000 0.7407 6.4725 1.4545 98.0392 0.6466
CAN $ 0.7500 — 12.0000 0.5556 4.8544 1.0909 73.5294 0.4850
Peso 0.0625 0.0833 — 0.0463 0.4045 0.0909 6.1275 0.0404
Euro € 1.3500 1.8000 21.6000 — 8.7379 1.9636 132.3529 0.8729
HK $ 0.1545 0.2060 2.4720 0.1144 — 0.2247 15.1471 0.0999
AUS $ 0.6875 0.9167 11.0000 0.5093 4.4498 — 67.4020 0.4446
Jap ¥ 0.0102 0.0136 0.1632 0.0076 0.0660 0.0148 — 0.0066
Pound £ 1.5465 2.0620 24.7440 1.1456 10.0097 2.2495 151.6176 —
Difference in Rates
U.S. $ CAN $ Peso Euro € HK $ Aus $ JAP ¥ Pound £
U.S. $ — 0.0000 0.0000 0.0000 0.0000 0.0000 0.0000 0.0000
CAN $ 0.0000 — 0.0000 0.0000 0.0000 0.0000 0.0000 0.0000
Peso 0.0000 0.0000 — 0.0000 0.0000 0.0000 0.0000 0.0000
Euro € 0.0000 0.0000 0.0000 — 0.0000 0.0000 0.0000 0.0000
HK $ 0.0000 0.0000 0.0000 0.0000 — 0.0000 0.0000 0.0000
AUS $ 0.0000 0.0000 3.0000 0.0000 0.0000 — 0.0000 0.0020
608 Brooks ◼ Financial Management: Core Concepts, 4e
2: NPV in foreign and home currency.
Solutions to Mini-Case
Scholastic Travel Services, Inc.
1. In the summer of 2011, a budget crisis in Greece sparked occasionally violent protest
demonstrations in Athens. A few weeks later a right-wing extremist in Norway bombed
government buildings in Oslo and then went on a shooting spree, killing sixty-nine young
campers. In early August, violent riots broke out in London after police shot and killed
twenty-nine-year-old Mark Duggan while attempting to arrest him. Shortly before the
start of the fall term, anxious families withdrew more than a third of the students enrolled
in UK programs and requested full refunds, even though their contract with Scholastic
Travel specified a 50% refund for withdrawals after June 30. Scholastic Travel also faced a
higher than normal withdrawal rate from other programs in western Europe.
O’Brien Athletic Equipment Year
CF in AUS $ PV in AUS $
Fwd.
Indirect
rates
CF in US$ PV in US $
0 (325,000,000) (325,000,000)
1.455 (223,437,500) -223,437,500
Inflation Rate Australia 3.7500% 1
12,000,000 10,294,973 1.462 8,210,241 7,077,794
Inflation Rate United States 3.2500% 2
36,000,000 26,496,617 1.469 24,512,021 18,216,424
WACC in US 16.0000% 3
58,000,000 36,623,504 1.476 39,301,268 25,178,659
WACC in Australia 16.5617% 4
74,000,000 40,087,372 1.483 49,901,344 27,560,068
Indirect Exchange Rate 1.4545$ 5
81,000,000 37,644,787 1.490 54,358,504 25,880,791
6
86,000,000 34,289,586 1.497 57,435,828 23,574,091
7
92,000,000 31,469,916 1.505 61,146,868 21,635,567
8
95,000,000 27,878,881 1.512 62,836,494 19,166,730
9
97,000,000 24,421,224 1.519 63,850,166 16,789,591
10
99,000,000 21,383,306 1.527 64,852,608 14,701,023
11
102,000,000 18,900,957 1.534 66,495,825 12,994,408
12
104,000,000 16,533,353 1.541 67,472,919 11,366,680
13
105,000,000 14,320,588 1.549 67,793,400 9,845,404
14
94,000,000 10,998,751 1.556 60,398,746 7,561,641
15
63,000,000 6,324,119 1.564 40,284,927 4,347,832
Net Present Value AUS $ 26,343,815
Net Present Value US $ 18,111,373
Accept
Chapter 18 ◼ International Financial Management 609
© 2018 Pearson Education, Inc.
locations, so many of them would react more dramatically to such an incident in Spain
than they might have if it had happened in a major U.S. city.
Business risk: The incident illustrates how uncontrollable adverse events in a foreign
country can have a major negative impact on sales and profits.
b. How should Scholastic Travel respond to the requests for refunds?
2. Ashley and Michaela are participating in a Scholastic Travel college program in Turin, Italy.
On a weekend trip to Switzerland, they stop at an outdoor café for coffee and pastry and
to and observe the Geneva sidewalk scene. The two cafes au lait and two chocolate
croissants came to 19.25 Swiss francs. Because they had not had a chance to exchange any
currency, they ask if they can pay in euros or dollars. The server says the price will be the
same either way, $14.56 or 10.26 euros.
a. What exchange rates between dollars and Swiss francs and dollars and euros are
implied by these prices?
b. What is the implied cross rate between euros and Swiss francs?
c. The actual exchange rates at the time were $1.00 equals €.705 or SFr1.374. Why might
these rates differ slightly from the rates calculated in part (a)?
d. Should Ashley and Michaela pay in dollars or euros?
610 Brooks ◼ Financial Management: Core Concepts, 4e
e. At a Starbucks in the Boston, Massachusetts, suburb of Newton, Ashley’s and
Michaela’s hometown, a latte costs $3.50 and a chocolate croissant costs $2.50.
If these orders are close substitutes for what they ordered at the Swiss café, does
purchasing power parity prevail? Why or why not? Is arbitrage possible?
612 Brooks ◼ Financial Management: Core Concepts, 4e
Additional Problems with Solutions
1. Currency exchange rates. On the day you arrive in New Zealand, the exchange rate for U.S.
dollars and New Zealand dollars is $1:2.25 NZ$. While you remain in New Zealand for the
next few months, the exchange rate falls to $1:$1.75439 NZ$. When you entered New
Zealand, you converted U.S.$10,500 to NZ$. As you leave New Zealand, you have NZ$ 400.
How much did you spend in New Zealand in U.S. dollars? Did the movement in the exchange
rate help or hurt you?
ANSWER (Slides 18-41 to 18-42)
2. Cross rates. You plan on traveling to South Korea and China on a business trip. You will first
stop in Korea, where the current direct exchange rate is $1: 1243.78SK won. You will next
stop in China, where the current direct exchange rate is $1: yuan 6.83013. As you leave
South Korea, you have 825,000 won and need to convert it to yuan. What is the cross-rate
for yuan, and how many yuan do you get for your won? Verify by converting won back to
dollars and then dollars to yuan.
ANSWER (Slides 18-43 to 18-44)
Chapter 18 ◼ International Financial Management 615
ANSWER (Slides 18-47 to 18-48)
Forward indirect rates:
A depreciating euro signifies higher inflation in the next six months for Europe versus the United
States.
5. Domestic NPV approach. Kalamazoo Marine wants to expand its operations to New
Zealand. The current indirect exchange rate is 1.75 for U.S. and New Zealand dollars. The
anticipated inflation rate is 3.8% in the United States, but only 1.75% in New Zealand. The
discount rate in the United States for the expansion project is 16%. If the following after-tax
cash flows have been forecasted for the expansion project in NZ$, should Kalamazoo Marine
expand to New Zealand?
Investment: NZ$ 60,000,000
Cash Flows: Year 1: NZ$7,000,000
Year 2: NZ$10,000,000
Year 3: NZ$ 25,000,000
Year 4: NZ$ 19,000,000
Year 5: NZ$ 17,000,000
Year 6: NZ$ 5,000,000
616 Brooks ◼ Financial Management: Core Concepts, 4e
ANSWER (Slides 18-49 to 18-51)
Anticipated forwards:
Cash Flows:
$ value Present Value