Question

Beta Inc. wants to construct a manufacturing plant in Brazil. The construction will cost 900 million Brazilian Real. Beta intends to operate the plant for 3 years. During the 3 years of operation, Real (BRL) cash flows are expected to be 300 million BRL, 300 million BRL, and 200 million BRL, respectively.

Operating cash flows will begin 1 year from today and are remitted back to the Canadian parent at the end of each year. At the end of the third year, beta expects to sell the plant for 500 million BRL.

Beta has a required rate of return of 17%. It currently takes 2.8743 BRL to buy 1 Canadian dollar, and the BRL is expected to depreciate by 5 percent per year.

A. Determine NPV of the project. Should Beta build the plant?

B. If the required rate of return is 12%, revised salvage value is 650 million BRL and BRL depreciates by 7.5% every year, what will be the new NPV?

ANSWER

A.

	YEAR 0	YEAR 1	YEAR 2	YEAR 3
Cash Flow BRL	-900 million BRL	300 million BRL	300 million BRL	200 million BRL
EXCHANGE RATE	2.8743	3.0180	3.1689	3.3274
Converted Cash flow in CAD	-2,586,870,000 CAD	905,400,000 CAD	950,670,000 CAD	665,480,000 CAD
Required rate of return %
PV factor@17%
PRESENT VALUE
NPV	Cumulative PV- Initial Investment

DECISION

ACCEPT / REJECT = ?

B.

	YEAR 0	YEAR 1	YEAR 2	YEAR 3
Cash Flow BRL
EXCHANGE RATE
Converted Cash flow in CAD
Required rate of return %
PV factor@12%
PRESENT VALUE
NPV	Cumulative PV- Initial Investment

DECISION - ACCEPT/REJECT

=

Answer 1

1. Scenario 1

The details given are:

a. Cash flows

in Million

Particulars	Year 0	Year 1	Year 2	Year 3	Year 3 (sale value)
Net Cash flows in BRL	(900.00)	300.00	300.00	200.00	500.00

b. Rate of return 17%

c. 1 CAD = 2.8743 BRL. yearly depreciation at 5% and hence CAD shall be

Particulars	Year 0	Year 1	Year 2	Year 3	Year 3 (sale value)
Exchange rate -BRL for 1 CAD	2.87	3.02	3.17	3.33	3.33
Calculation		year 0 x 1.05	year 1 x 1.05	year 2 x 1.05

The NPV is computed as given below:

in Million

Particulars	Year 0	Year 1	Year 2	Year 3	Year 3 (sale value of plant)	Total
Net Cash flows in BRL	(900.00)	300.00	300.00	200.00	500.00	400.00
Exchange rate -BRL for 1 CAD	2.87	3.02	3.17	3.33	3.33
Net Cash flows in CAD (BRL cash flows/  Exchnage rate)	(313.12)	99.40	94.67	60.11	150.27	91.33
Discounting at 17% Rate of Return (refer note)	0.85	0.73	0.62	0.53	0.53
NPV in CAD = (Net cash flows in CAD x DCF)	(267.62)	72.62	59.11	32.08	80.19	(23.63)
Note: DCF Calculation	1/(1.17)^1	1/(1.17)^2	1/(1.17)^3	1/(1.17)^4	1/(1.17)^4

Since the NPV is CAD -23.63 million, the project is not viable and hence should not buy.

Scenario 2

1. Sale Value changed to 650 million BRL

2. Rate of return 12%

3. BRL depreciates at 7.5%

Particulars	Year 0	Year 1	Year 2	Year 3	Year 3 (sale value)
Exchange rate -BRL for 1 CAD	2.87	3.09	3.32	3.57	3.57
Calculation		year 0 x 1.075	year 0 x 1.075	year 0 x 1.075

The revised NPV calculations are:

in Million

Particulars	Year 0	Year 1	Year 2	Year 3	Year 3 (sale value of the plant)	Total
Net Cash flows in BRL	(900.00)	300.00	300.00	200.00	650.00	550.00
Exchange rate -BRL for 1 CAD	2.87	3.09	3.32	3.57	3.57
Net Cash flows in CAD (BRL cash flows/  Exchnage rate)	(313.12)	97.09	90.32	56.01	182.04	112.34
Discounting at 12% Rate of Return (refer note)	0.89	0.80	0.71	0.64	0.64
NPV in CAD = (Net cash flows in CAD x DCF)	(279.57)	77.40	64.29	35.60	115.69	13.40
Note: DCF Calculation	1/(1.12)^1	1/(1.12)^2	1/(1.12)^3	1/(1.12)^4	1/(1.12)^4

This scenario has a positive NPV of CAD 13.40 million