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Following is my query in Okan Co (Sep/Dec 19) model answer “Working 3 – Component Cost” :-
Information given at T0-
The expected spot exchange rate between Y$ and GBP , In Six Month’s time is expected to be Y$ 3.03 per GBP.
The Annual inflation rates are currently 2% in UK and 4% in Yasailand.Hence the forecast of Y$ per GBP at T1 should be 3.03 *(1.02/1.01) = 3.06 .Note- I have considered inflationof only 6 months here as the rate 3.03 is the rate at T0.5.
BUt the model answer considers the full year’s inflation on the T0.5 (six month) rate.
The examiners answer is correct.
The project starts in 6 months time, (which is time 0), and the first operating cash flows will occur 12 months after the start (i.e. in 18 months time) and so this is time 1.
The exchange rate in 6 months time is expected to be 3.03, and therefore the exchange rate 12 months after that will be 3.03 x (1.04/1.02)
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