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CA Final · Advanced Financial Management · International Financial Management

Bharat Auto Components Ltd is evaluating a project in Thailand. Which approach to discounting is consistent when the project cash flows are first forecast in Thai baht (THB)?

Discount baht cash flows at a baht-based required rate and convert the resulting NPV into rupees at the spot rate. The currency of the cash flows must match the currency of the discount rate, otherwise inflation and interest differentials between the two countries are ignored and the valuation is distorted.

  1. ADiscount THB cash flows at a THB-based rate, then convert the resulting NPV at the spot rateCorrect
  2. BDiscount THB cash flows at the Indian rupee cost of capital, then convert at the spot rate
  3. CConvert THB cash flows at today's spot rate for all years and discount at a THB rate
  4. DDiscount THB cash flows at the rupee rate and convert each year's result at the forward rate

Explanation

Currency of cash flows and discount rate must match. THB flows need a THB-risk-adjusted rate, and the NPV in THB is converted at spot to rupees. Using a rupee rate on THB flows (option 2) mixes currencies and ignores the inflation differential.

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