Question16 An Australian firm is evaluating a Japanese investment. The project has a Net Present Value (NPV) of -50 million JPY when measured in local currency, but an NPV of +200 million AUD when converted for the Australian parent company (parent company's perspective). Which of the following statements is NOT true? Select one alternative: a. The company should not take this investment opportunity since the project is not intrinsically valuable. b. The NPV difference implies that the exchange rate is expected to be favorable for the parent. c. The company should take this project if it can fully hedge the currency risk for the project. d. The NPV of the project will increase if the Japanese government provides tax benefits (such as eliminating the tax for 3 years). ResetMaximum marks: 1 Flag question undefined单项选择题
A
a. The company should not take this investment opportunity since the project is not intrinsically valuable.
B
b. The NPV difference implies that the exchange rate is expected to be favorable for the parent.
C
c. The company should take this project if it can fully hedge the currency risk for the project.
D
d. The NPV of the project will increase if the Japanese government provides tax benefits (such as eliminating the tax for 3 years).

Question

Question16 An Australian firm is evaluating a Japanese investment. The project has a Net Present Value (NPV) of -50 million JPY when measured in local currency, but an NPV of +200 million AUD when converted for the Australian parent company (parent company's perspective). Which of the following statements is NOT true? Select one alternative: a. The company should not take this investment opportunity since the project is not intrinsically valuable. b. The NPV difference implies that the exchange rate is expected to be favorable for the parent. c. The company should take this project if it can fully hedge the currency risk for the project. d. The NPV of the project will increase if the Japanese government provides tax benefits (such as eliminating the tax for 3 years). ResetMaximum marks: 1 Flag question undefined单项选择题

A

a. The company should not take this investment opportunity since the project is not intrinsically valuable.

B

b. The NPV difference implies that the exchange rate is expected to be favorable for the parent.

C

c. The company should take this project if it can fully hedge the currency risk for the project.

D

d. The NPV of the project will increase if the Japanese government provides tax benefits (such as eliminating the tax for 3 years).

BlackTom AI · Accepted Answer

A project can be value-destroying in the host currency yet value-adding to the parent when exchange‑rate expectations, taxes, and the parent’s discounting differ from the host view. That is why statement (a) is NOT true.

1) Relevant knowledge points and concepts
- Net Present Value (NPV): present value of cash inflows minus outflows in a currency and discount rate appropriate to the investor.
- Parent vs. local perspective: host-country NPV uses local cash flows and local discounting; parent NPV converts those cash flows (or the local NPV) into parent currency using expected exchange rates and the parent’s discount rate.
- Exchange‑rate expectations and hedging: expected currency movements (or forward/hedge contracts) can make repatriated cash flows larger or smaller in parent currency.
- Tax treatment: changes in host-country taxes directly alter local cash flows and therefore both local and parent NPVs.

2) Step‑by‑step reasoning
- Given: NPV_local = –50 million JPY; NPV_parent = +200 million AUD.
- These figures imply that when the project’s expected local cash flows are converted (using expected future exchange rates and discounted at the parent’s required return) the project yields +200 AUD overall, even though it is negative when valued purely in JPY and with local discounting.
- The parent’s decision criterion is to maximize parent‑shareholder wealth; a positive parent‑currency NPV is therefore attractive to the parent.

3) (No complex numeric calculation provided by question) The conceptual conversion relationship is:
NPV_parent = sum_t E[CF_t (JPY) × S_t (AUD/JPY)] discounted at parent’s discount rate.
This can yield a positive number even if sum_t CF_t discounted in JPY yields –50 million JPY, because S_t (expected exchange rate path) and discounting differ.

4) Why the correct answer is correct
- Statement (a) claims “The company should not take this investment opportunity since the project is not intrinsically valuable.” This is incorrect because the project is intrinsically valuable to the parent (NPV_parent = +200 AUD). The parent’s objective is parent‑currency shareholder value; a project negative in local terms can still add value to parent shareholders due to expected currency gains or other parent‑level benefits.

5) Why the other options are correct (brief)
- (b) True: a positive parent NPV despite negative local NPV implies expected exchange‑rate movements (or favorable translation) that increase repatriated value.
- (c) True: if the parent can fully hedge the currency risk at favorable forward rates consistent with the +200 AUD outcome, the parent can lock in that positive value.
- (d) True: host‑country tax relief increases local after‑tax cash flows, raising the local NPV (making it less negative or positive) and therefore increasing the parent NPV as well.