International Capital Budgeting

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One way to evaluate international projects is to estimate cash flows in the foreign currency, forecast exchange rates at which these cash flows can be converted to dollars, and then discount at the dollar cost of capital. A second way is to directly discount the foreign currency cash flows at an appropriate cost of capital for the foreign currency. Given forecasts of inflation rates, Relative Purchasing Power Parity implies a forecast of exchange rates. Also, given forecasts of inflation rates and a dollar cost of capital, the Fisher Hypothesis (that real rates of interest are equal) implies a cost of capital in the foreign currency. Relative Purchasing Power Parity and the Fisher Hypothesis are different assumptions but give the same dollar NPV.
Source: Professor Kerry Back (Washington University in St. Louis)
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Subjects: Finance, Spreadsheets
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