One of your clients, a wealthy Houstonian,

One of your clients, a wealthy Houstonian, asks you to evaluate the following investment in a mining venture in Mexico, and to hedge the cash flows (receivables). The investment (outlay) is USD 3.0-million. Your client requires a rate of return of 20 percent in USD. The venture is an on-going concern that has generated free cash flows of MXP21 million per year, and American geologists project that it will continue to do so for the next three years at which point it will cease. There is no salvage value. The current spot rate is $0.08/MXP, and currently nominal interest rates on one- through three-year paper are as follows:

Term (yrs) US Mexico

1 2% 5%

2 2.5 8

3 2.7 11

Using Excel answer the following questions:

1-If you hedged using forward contracts, what is the predicted NPV?

2-If you hedged using forward contracts, what is the predicted IRR?

3-What would NPV have been if you did not hedge, and if the following exchange rates were observed ex-post?

Year Exchange Rate

1 $.070

2 $.065

3 $.050