Read curple 24 1. -d 5: E S Foreign Project NPV Example Basil, Inc. a US manufacturer wants to use WACC technique to value a foreign project in the UK. The project will be self-contained in the UK such that all revenues are generated and all costs incurred there. Engineers expect the technology used in the new products in the project will become obsolete in four years. The marketing group expects that annual sales will be £37.5 million per year for the new product. Manufacturing costs and operating expenses are expected to total £15.625 million and £5.625 million per year. respectively. Developing the product will require an upfront investment of £15 million in capital equipment that will be obsolete in four years and an initial marketing expense of £4.167 million. Basil pays a corporate tax rate of 40% regardless of which country it manufactures its products in. The company's expected free cash flows are provided in the table below. The company's managers have determined that there is no correlation between the uncertainty in these cash flows and the uncertainty in the spot dollar-pound exchange rate. Thus the expected value of future cash flows in dollars is the expected value in pounds multiplied by the forward exchange rate. Basil's managers have decided to use covered interest parity to compute forward rates. The current spot rate, S, is $1.60/£, the risk-free rate on dollars is 4% and that on pounds is 7%. Assume that the market risk of the UK project is similar to that of the company as a whole, so that the WACC can be computed from its debt and equity costs in the USA. The current market value balance sheet shows a build-up of $20 million in cash for investment needs, while its total debt is $320 million so that its net debt is $300 million. This implies a debt to equity ratio of 1. Use forward rates to convert the pound free cash flows into dollar free cash flows. Determine the WACC and use it to value the project in dollars for Basil. What is your recommendation to Basil? Expected Dollar FCF from Project Basil UK 0 1 2 3 4 1. Pound Free Cash Flow(£ million) (17.500) 11.250 11.250 11.250 11.250 2. Forward Exchange Rate($/£) 3. Dollar Value of Pound FCF(1X2) Current Market Value Balance Sheet ($ Million) Assets Cash Existing Assets 600 Equity Liabilities 20 Debt 320 Debt Cost of Capital 6% 300 Equity 10% 620 620

Read curple 24 1. -d 5: E S Foreign Project NPV Example Basil, Inc. a US manufacturer wants to use WACC technique to value a foreign project in the UK. The project will be self-contained in the UK such that all revenues are generated and all costs incurred there. Engineers expect the technology used in the new products in the project will become obsolete in four years. The marketing group expects that annual sales will be £37.5 million per year for the new product. Manufacturing costs and operating expenses are expected to total £15.625 million and £5.625 million per year. respectively. Developing the product will require an upfront investment of £15 million in capital equipment that will be obsolete in four years and an initial marketing expense of £4.167 million. Basil pays a corporate tax rate of 40% regardless of which country it manufactures its products in. The company's expected free cash flows are provided in the table below. The company's managers have determined that there is no correlation between the uncertainty in these cash flows and the uncertainty in the spot dollar-pound exchange rate. Thus the expected value of future cash flows in dollars is the expected value in pounds multiplied by the forward exchange rate. Basil's managers have decided to use covered interest parity to compute forward rates. The current spot rate, S, is $1.60/£, the risk-free rate on dollars is 4% and that on pounds is 7%. Assume that the market risk of the UK project is similar to that of the company as a whole, so that the WACC can be computed from its debt and equity costs in the USA. The current market value balance sheet shows a build-up of $20 million in cash for investment needs, while its total debt is $320 million so that its net debt is $300 million. This implies a debt to equity ratio of 1. Use forward rates to convert the pound free cash flows into dollar free cash flows. Determine the WACC and use it to value the project in dollars for Basil. What is your recommendation to Basil? Expected Dollar FCF from Project Basil UK 0 1 2 3 4 1. Pound Free Cash Flow(£ million) (17.500) 11.250 11.250 11.250 11.250 2. Forward Exchange Rate($/£) 3. Dollar Value of Pound FCF(1X2) Current Market Value Balance Sheet ($ Million) Assets Cash Existing Assets 600 Equity Liabilities 20 Debt 320 Debt Cost of Capital 6% 300 Equity 10% 620 620

International Financial Management

14th Edition

ISBN:9780357130698

Author:Madura

Publisher:Madura

Chapter15: International Corporate Governance And Control

Section: Chapter Questions

Problem 5QA

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