ABC LTD, a U. multinational enterprise is contemplating making a foreign capital expenditure in South Africa. The initial cost of the project is...

ABC LTD, a U.K. multinational enterprise is contemplating making a foreign capital expenditure in South Africa. The initial cost of the project is ZAR50 million. The annual cash flows over the five year economic life of the project are estimated to be ZAR13 million, ZAR18 million, ZAR25 million, ZAR10 million, and ZAR9 million. The parent firm's cost of capital in pounds is 7.5 percent. Long-run inflation is forecasted to be 4 percent per annum in the U.K. and 12 percent in South Africa. The current spot foreign exchange rate is ZAR/₤ = 15.56. Determine the NPV for the project in ₤ by:

(a) Calculating the NPV in ZAR using the ZAR equivalent cost of capital according to the Fisher Effect and then converting to ₤ at the current spot rate. [5]

(b) Converting all cash flows from ZAR to ₤ at Purchasing Power Parity forecasted exchange rates and then calculating the NPV at the pound cost of capital. [7]

(c) What is the NPV in pounds if the actual pattern of ZAR/₤ exchange rates is:

S(0) = 15.56, S(1) = 14.56, S(2) = 16.72, S(3) = 15.78, S(4) = 16.54, and S(5) = 16.32? Justify the difference in the actual and the forecasted NPV [5]

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