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ACCA Strategic Professional · Advanced Financial Management · International investment and financing decisions

A UK company is appraising a project in Brazil. Cash flows are forecast in Brazilian reais (BRL) and converted using forecast spot rates. Which approach to the discount rate is consistent with this method?

Cash flows converted into sterling should be discounted at a sterling-based, risk-adjusted cost of capital. Applying a Brazilian reais rate to sterling flows mixes currencies and double counts the inflation differential already reflected in the forecast exchange rates.

  1. ADiscount the sterling cash flows at a sterling-based cost of capital reflecting the project's riskCorrect
  2. BDiscount the BRL cash flows at the UK sterling cost of capital
  3. CDiscount the sterling cash flows at the Brazilian risk-free rate
  4. DDiscount the sterling cash flows at the BRL cost of capital

Explanation

If cash flows are converted into sterling, the discount rate must be a sterling rate adjusted for the project's risk. Using a BRL rate on sterling flows mixes currencies and double counts inflation differences already captured in forecast exchange rates.

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