# Calculating the Exchange rate between currencies after taking into account inflation

Question

Toshiyuki Matsukawa is production manager for Tanaka Chemicals, a Japanese chemical manufacturer operating throughout Asia. He is considering a proposal to build a chemical plant in Thailand to service the growing Southeast Asian market. The project information is as follows:

The exchange rate is currently S0Bt/¥  = 0.2500 Bt/¥. The manufacturing plant will cost Bt 4 million and will take one year to construct. Assume the Bt 4 million cost will be paid in full at the end of the year (at t=1). The real value of the manufacturing plant is expected to remain at Bt 4 million throughout the life of the project. The plant is to be sold at project’s end. Production begins in one year (at t=1) with annual; revenues of Bt 1000 million per year (in nominal terms) over the 4-year life of the project. Fixed expenses are contractually fixed in nominal terms at Bt 5million each year over the life of the project. Variable costs are 90 percent of gross revenues. Assume end-of-year cash flows. The plant will be owned by a subsidiary in Thailand and will be depreciated to zero on a straight line basis.  Taxes are 40% in Thailand. Annual inflation is expected to be 105 in Thailand and 5% in Japan. The required rate of return on similar projects in Thailand is 20%. Assume that the international parity conditions hold.

a. Calculate the Thai Bhat (Bt) value of this investment proposal from the local (Thai) point of view.
b. What is the nominal required rate of return for similar projects in Japan?
c. Identify the expected future spot exchange rates for each cash flow.
d. Calculate the yen value of the project from the local and parent perspective. Are the answers equivalent? Why?

Summary

The question belongs to Finance and it is about a Japanese company which wants to invest Thailand. The exchange rate between Thai currency and Japanese currency needs to be calculated. This calculation shall take into account inflation.

Total Word Count 125

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