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Applied International Finance II, Second Edition by Thomas O'Brien

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CHAPTER 4

Converting Hurdle Rates and Expected Cash Flows Across Currencies

The theory of cross-border investments is generally based on the standard concept of discounting a project’s expected operating cash flows back to the present using a cost of capital (or hurdle rate) that reflects the risk. An investment’s net present value (NPV) is the present value of the expected cash flows minus the outlay necessary to undertake the investment. If the NPV is positive, the investment should be accepted, because the intrinsic wealth of the firm’s existing shareholders would rise. If the NPV is negative, the investment should be rejected, because intrinsic wealth of the firm’s existing shareholders would drop.

One issue is whether to consider a foreign ...

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