Wendy lives in London and is considering opening a restaurant

in Neverland, an
imaginary world in which markets are perfect and the
international parity conditions
hold. Neverland is governed by the dread pirate Captain Hook, a
vindictive tyrant
with a consuming jealousy of Wendy and her friend Peter.

The details of Wendy’s Neverland project are shown below:

- The current spot rate of exchange between the croc and the
pound is Cr4.00/£.
− The project lasts four years, at which time Wendy grows up.
(Only Peter stays young forever.)
− An initial investment of £10,000 (Cr40,000) will purchase
Captain Hook’s ship.
− An additional £6,000 (Cr24,000) will be needed for inventory
at that time. Increases in other current asset accounts are offset
by increases in current liabilities, so the increase in net working
capital (current assets minus current liabilities) is also £6,000.
− Expected annual sales are Cr30,000, Cr60,000, Cr90,000, and
Cr60,000 in nominal terms.
− Variable operating costs (wages to Lost Boys) are 20 percent
of sales.
− Fixed maintenance costs on the ship are Cr2,000 at the end of
the first year and are expected to increase at the rate of inflation
thereafter.
− The ship will be owned by the foreign subsidiary. Neverland’s
tax code calls for the ship to be depreciated on a straight-line
basis over four years to a zero salvage value.
− The inventory will be sold at the end of the project and is
expected to retain its Cr24,000 real value.
− The ship is expected to retain its Cr40,000 real value.
− Income taxes are 50 percent in both the United Kingdom and
Neverland. Capital gains on the sale of the ship and inventory at
the end of the project are also taxed at 50 percent.
− All cash flows except the initial investment occur at the end of
the year.

Wendy will purchase one of Captain Hook’s ships and convert it

into a fast-food restaurant tosatisfy the appetites of the many
pirates on the island. The ship is ship-shape and
Wendy (with a little help from Peter) can have the galley ready
for business at time
t = 0. Wendy will invest the necessary equity capital. Peter will
serve as the local
manager of the restaurant, and the local Lost Boys will provide
the labor.
The parity conditions are known to hold (this is an imaginary
land), so the real required return on risk-free government bills
should be the same in both British pounds sterling (Wendy’s
currency) and Never-
land crocs (the foreign currency). Real required return on
restaurant projects is the same in both currencies - 10.18% per
year i.
Expected inflation in Pounds is approximately 8.91%, in Crocs -
36.14% per year.Calculate NPV and IRR in both currencies