Question

1. Eurobike in Germany considers an investment in Turkey to produce bicycles. The initial investment for the project is €2 mn and the factory is expected to generate cashflows of TL5 mn in year1, TL5 mn in year 2, TL9 mn in year 3, TL15 mn in year 4 and TL10 mn in year 5. Salvage value of the factory is €500,000.

Spot rate of EURTL is 7 and TL is expected by depreciate by 5% each year in the next 5 years.

Eurobike requires a 20% return from the project.

1. Should Eurobike do the project? (10 points)
2. Assume the project doesn’t go as planned and generates only TL1 mn cashflow in year 1 and 2 and cashflow is expected to grow by only 10% until the end of the project. Salvagew value remains at €500,000. A local competition wants to buy the project for €1 mn at year 3. Should Eurobike sell? (10 points)

Answer 1

We will analyze this using PW method
PW = Cash Flow / (1+Discount Rate)^Duration

PW of initial investment = -2 million Euro

a) Now we will have to convert Turkish Lira into Euro using given exchange rate
1st year
5000000 / 7 = 714285.71 Euro
714285.71 / (1.20) = 595238.10

2nd year
The Turkish Lira depreciated by 5%
7 * 1.05 = 7.35

5000000 / 7.35 = 680272.11

680272.11 / (1.20 ^ 2) = 472411.19

We will create a table for all the values

Year	Turkish Lira	Exchange Rate	Euro	PW @ 20%
0			-2000000.00	-2000000.00
1	5000000	7.0000	714285.71	595238.10
2	5000000	7.3500	680272.11	472411.19
3	9000000	7.7175	1166180.76	674873.12
4	15000000	8.1034	1851080.57	892689.32
5	10000000	8.5085	1175289.25	472322.39
		Salvage Value	500000.00	200938.79
		NPW		1308472.90

The net present worth of the discounted cash flow is positive so the project is acceptable.

b) Now the cash flow is less than the expectations so we will again calculate the values.

Year	Turkish Lira	Exchange Rate	Euro	PW @ 20%
0			-2000000.00	-2000000.00
1	1000000	7.0000	142857.14	119047.62
2	1000000	7.3500	136054.42	94482.24
3	1100000	7.7175	142533.20	82484.49
4	1210000	8.1034	149320.50	72010.27
5	1331000	8.5085	156431.00	62866.11
		Salvage Value	500000.00	200938.79
		NPW		-1368170.48

PW after 3 years = -1703985.65
PW of salvage value = 500000 / (1.20^3) = 289351.85
NPW = -1414633.80

The net present worth in the case of unexpected decrease in cash flow is negative.
The Eurobike should accept the offer of Euro 1 million as it will reduce its losses.