NPV - Project with the assumption different currency

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Permalink Reply by Dimitris Grypeos on June 16, 2009 at 3:38am

Chau,
I will slightly vary your question. Lets say you had some EUR in your pocket and you would like to invest them. Lets assume you had 2 options:
1. Invest this EUR sum and earn a EUR interest rate
2. Convert EUR into USD at the spot exchange rat -> Earn a USD interest rate -> Convert into EUR using the forward exchange rate
Assuming that there is no arbitrage (i.e. interest rate parity holds) the two alternatives should yield equivalent EUR returns.
Going back to your question now and the example that you include in your model. You make an implicit assumption about the forward exchange rate, namely that the USD will depreciate by 4% against the EUR each year. Following the interest rate parity this implies that interests on EUR and USD should be different. The interest rate differential should be equal to the exchange rate differential implied by the Forward and the Spot exchange rate. Therefore, once you made an implicit assumption about the forward exchange rate you should adjust the interest rate accordingly. Your IRR calculation reflects this point correctly. I attach your excel file with some additional calculations to show this case.
I believe that you may also find useful the following link:

Hope this helps
Dimitris

Attachments:

• Projectwithanothercurrency_v2.xls, 25 KB

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Permalink Reply by Chau Van Phuoc on June 16, 2009 at 7:23am

Thanks Dimitris,

The file is useful for me. However, this calculation is only right when we assume that the depreciation of the USD against the EUR is a fixed rate (i.e 4%). If we change this rate every year, the final result will have a different with original.

I just read a book (Investment Valuation) from Damodaran and there is a comments that we can choose a prefer assumption. However, this is so academic. In practically, we can assume the fixed rate growth of EURvsUSD for the best simple way.

Thanks lot!

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Permalink Reply by CHRISTOS BARDAS on June 17, 2009 at 6:32am

agapite dimitri

prosfata perasa se metaptyxiako programma ston Panepistimio Thessalias kai exw kanei kapoies arxikes ektimiseis panw sta oikonomika themata kai oti allo xreiastw. To provlima mou omws antimetwpizetai panw sto neo Excel 2007. Den gnwrizw arketa tis dunatotites tou opws kai tin Access 2007. Exeis kati na proteineis?

Fantazomai oti oi gnweis sou me vasi ta osa apantises ston chau to apodeiknuoun!

Me ektimisi

XPHSTOS MPARDAS

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Permalink Reply by Brent Wheeler on June 20, 2009 at 12:03am

The most important thing here is to ensure that the discount rate you use reflects the risks to the cashflows in the country they arise... so a company may well be incorporated in Delaware US but if the project is in India then it is Indian risk which we must discount for.... adjusting the resulting answer back to USD is simply a convenience.

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Permalink Reply by Thompson Terry on June 22, 2009 at 10:57am

The discount rate needs to be based on the location of the project. There will be exchange rate issues to factor into the model but the primary driver for the NPV rate is the risk associated with the place where the project is.

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