Question Details

Factors that Affect the NPV of a Divestiture



1. Foreign Divestiture Decision. Baltimore Co. considers divesting its six foreign projects as of
today. Each project will last one year. Its required rate of return on each project is the same. The
cost of operations for each project is denominated in dollars and is the same. Baltimore believes
that each project will generate the equivalent of $10 million in one year based on today-
exchange rate. However, each project generates its cash flow in a different currency. Baltimore
believes that interest rate parity (IRP) exists. Baltimore forecasts exchange rates as explained in
the table below.
a. Based on this information, which project will Baltimore be most likely to divest? Why?
b. Based on this information, which project will Baltimore be least likely to divest? Why?
Project
Comparison of One-year U.S.
and Foreign Interest Rates
Forecast Method Used to
Forecast the Spot Rate One
Year from Now
Country A The U.S. interest rate is higher
than currency A- interest rate
Spot rate
Country B The U.S interest rate is higher
than currency B- interest rate
Forward rate
Country C The U.S. interest rate is the
same as currency C- interest
rate
Forward rate
Country D The U.S. interest rate is the same
as Currency D- interest rate
Spot rate
Country E The U.S. interest rate is lower
than Currency E- interest rate
Forward rate
Country F The U.S. interest rate is lower
than Currency F- interest rate
Spot rate

2. Factors that Affect the NPV of a Divestiture. Washington Co. (a U.S. firm) has a subsidiary in
Germany that generates substantial earnings in euros each year. One week ago, it received an
offer from a company to purchase it, and it has not yet responded to this offer.
a. Since last week, the expected stream of euro cash flows has not changed, but the forecasts of
the euro- value in future periods have been revised downward. Will the NPV of the
divestiture be larger or smaller or the same as it was last week? Briefly explain.
b. Since last week, the expected stream of euro cash flows has not changed, but the long-term
interest rate in the U.S. has declined. Will the NPV of the divestiture be larger or smaller or
the same as it was last week? Briefly explain.



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