In a bid to gain greater acceptance in Asian markets, Wide BayCookies Ltd is evaluating an opportunity to produce and distributeits products from a new manufacturing plant in Vietnam. Wide Baywill invest AUD $3,000,000 to set up the factory and provideworking capital for operations. AUD $2,000,000 of this initialoutlay will be recovered when the project is terminated in fouryears’ time. Wide Bay expect to receive 13,000,000,000 VietnameseDong (VND) after tax for each of the four years of operation. Thecurrent spot rate is AUD VND 15 746.72.
The risk free rate in Australia is 1% while it is 4.45% inVietnam. You should assume that interest rate parity exists. WideBay Cookies works on the assumptions that the one year forward ratepredicts the spot rate in one years’ time and that the change inthe exchange rate in the first year will be repeated for each yearof the project. Wide Bay’s annual required return for the projectis 12%.
Rice Paper Ltd is an Australian company that imports Vietnameseproducts. Rice Paper’s contracts are written in Vietnamese Dong andthey agree to take 13,000,000,000 each year from Wide Bay Cookiesat the rate of AUD VND 14 000.
a)     Ignoring any tax implications,what is the net present value of the project for Wide Bay Cookiesif it does not hedge the project’s cash flows?
b)Â Â Â Â Ignoring any tax implications, whatis the net present value of the project for Wide Bay Cookies if itengages in the currency swap? Â Â
c)Â Â Â Â Â Should Wide Bay undertake theproject? Justify your answer.
