You have decided to change your job and you have just started at Finternational. So you are immediately given a task, which is a standard project that your company is typically involved in. Specifically, it involves buying the Great Wall of China. The wall is on a special sale, only 999 Chinese yuan if you call today. As a special bonus, you will also get a brand new, madein-China, Ming porcelain vase. You estimate that if you buy the Chinese Great Wall you will make 556.5 yuan in the first year and 590 yuan in the second year, at which point the wall will collapse entirely. Also, if you decide to go ahead with the deal, you can immediately sell the Ming vase to a Copenhagen antique store for 25 Danish kroner. Finally, from the local business newspaper, Der Standard, you see that the nominal risk-free rate is 8% in China and 2% in Austria, the current exchange rates are 0.133 EUR per yuan, 0.15 EUR to DKK, the expected inflation rate in China is 7%, and in Austria 1% a year. Finally, the weighted average cost of capital for your firm is 6% (for Austrian cash flows).
a.) Find the value of the project in EUR. Should you accept the deal?
b.) Your company is considering an import of porcelain from China from year 3 on. Is it a good idea? Will China become more or less expensive within next 3 years? (Assume that the forward rate is the best guess for the future spot rate.)
How do I value the project?