Question

     Brower, Inc. just constructed a manufacturing plant in Ghana. The construction cost 9 billion Ghanian cedi. Brower intends to leave the plant open for three years. During the three years of operation, cedi cash flows are expected to be 3 billion cedi, 3 billion cedi, and 2 billion cedi, respectively. Operating cash flows will begin one year from today and are remitted back to the parent at the end of each year. At the end of the third year, Brower expects to sell the plant for 5 billion cedi. Brower has a required rate of return of 17 percent. It currently takes 8,700 cedi to buy one U.S. dollar, and the cedi is expected to depreciate by 5 percent per year.

a.          Determine the NPV for this project. Should Brower build the plant

b. b.   How would your answer change if the value of the cedi was expected to remain unchanged from its current value of 8,700 cedis per U.S. dollar over the course of the three years? Should Brower construct the plant then?

Please show how to solve without using excel, thank you.

Answer 1

Before going into the solution let me brief you about the Net Present Value(NPV) and Discounting

Discounting is a process where you try to bring the money earned or to be earned in the future into the present terms with the help of discounting factor which is calculated by the following way

1/ (1+Rate of return) if discounting is for 1 year and repeat it as the period

The above formula can be used to calculate the discounting factor and if you multiply the cashflows with the factor we arrive at the present value

Now Net Present Value is defined as The difference between Sum of discounted cash inflows and discounted cash outflows.

Now let us look at the facts of the problem

Cost of construction (Cash Outflow) is 9billion cedi

Life is 3 years

The Operating Cash Inflows for three years are 3billion cedi, 3 billion cedi, and 2 billion cedi respectively.

The Sale value at the end of 3rd year is 5 billion cedi

The spot rate of US$ is 8700 cedi

The depreciation rate of cedi every year is 5%

SOLUTION: Question a

Let us compute the exchange rate of US$ for three years as the cedi is depreciating every year by 5%

Current Rate is 8700 cedi

After 1 year 8700+5%= 9135 cedi

After 2 years 9135+5%= 9592 cedi

After 3 years 9592+5%=10071 cedi

Let us Calculate the Cashflows in US$

Cash Outflow 9000,000,000 / 8700 cedi = $1,034,483

Cash Inflow at the end of year 1 is 3000,000,000 / 9135 cedi  = $328407

Cash Inflow at the end of year 2 is 3000,000,000/ 9592 cedi = $312760

Cash Inflow at the end of year 3 is 2000,000,000/ 10071 cedi =$198590

Cash Flows from Sale of Plant at the end of year 3 is 5000,000,000/ 10071 = $496475

Let us compute the Discounting factors for three years at the required rate of return of 17%

Discounting Factor at the Beginning of the year is 1

Discounting Factor after one year is 1 / 1.17 = 0.8547

Discounting Factor after 2 years is 1 / (1.17)*(1.17) = 0.7305

Discounting Factor after 3 years is 1 / (1.17)*(1.17) (1.17) = 0.6244

Let us Compute the Discounted Cashflows

Discounted Cash Outflow is $ 1034483 * 1 = ($1034483)

Discounted Cash Inflow year 1 $328407 *0.8547 = $280689

Discounted Cash Inflow year 2 $312760 *0.7305 = $228471

Discounted Cash Inflow year 3 $198590 *0.6244 = $124000

Discounted Cash Inflow year 3 $496475 *0.6244 = $309998

Total Discounted Cash inflows are $ 943158

Net Present Value is $ 943158 - $1034483 = ($91325).

It is Advised that Brower Inc is not recommended to construct the plant as it gives NEGATIVE NPV

A solution to Question b.

Here it is given that the exchange rate remains the same for three years so the cash flows are as follows

Cash Outflow 9000,000,000 / 8700 cedi = ($1,034,483)

Cash Inflow at the end of year 1 is 3000,000,000 / 8700 cedi  = $344828

Cash Inflow at the end of year 2 is 3000,000,000/ 8700 cedi = $344828

Cash Inflow at the end of year 3 is 2000,000,000/ 8700 cedi = $229885

Cash Flows from Sale of Plant at the end of year 3 is 5000,000,000/ 8700 = $574713

Let us Compute the Discounted Cashflows

Discounted Cash Outflow is $ 1034483 * 1 = ($1034483)

Discounted Cash Inflow year 1 $344828 *0.8547 = $294724

Discounted Cash Inflow year 2 $344828 *0.7305 = $251897

Discounted Cash Inflow year 3 $229885 *0.6244 = $143540

Discounted Cash Inflow year 3 $574713 *0.6244 = $358850

Total Discounted Cash inflows are $ 1049011

Net Present Value is $ 1049011 - $1034483 = $14528

It is Advised that Brower Inc construct the plant as it gives POSITIVE NPV

NOTE: Feel Free to revert back for any further clarifications

Warm Regards

Latheef khan