Question

A U.S.-based firm is considering a five- year project in Colombia. The following information is available about the project: Initial investment. The initial investment of USD 750,000 is used to purchase capital equipment. This equipment will be depreciated straight line to zero. At the end of five years, the remaining equipment will be sold for Colombian Peso (COP) 12,000,000. Working capital. The investment in working capital is COP 180,000,000. There are no changes in working capital until the end of the project when the full amount is recovered. Units, price, and costs. The firm will produce 1750 units of a product annually. The selling price is expected to be COP 599000 in the first year. This price is expected to increase at a rate of 3 percent annually. The direct expense per unit is expected to be COP 240000 in the first year. This is expected to increase at a rate of 7 percent annually. Indirect expenses are expected to be COP 75,000,000 annually. Taxes and miscellaneous. Colombian taxes on income and capital gains are 33 percent. There are no additional withholding taxes. All cash flows are repatriated when generated, and there are no additional U.S. taxes. The parity conditions are assumed to hold between Colombia and the United States. The
FINC 6367 – International finance Excel Homework Page 2
relevant inflation indexes indicate a rate of 2.5 percent for the United States and 6 percent for Colombia. Spot USDCOP equals 2900. Brady’s USD denominated WACC is 12.5 percent.

a. Calculate COP cash flows.

b. What is the appropriate COP discount rate? Calculate the project NPV.

c. Use parity conditions to generate future spot rates. Calculate the project NPV in USD.

d. Calculate break- even units.

e. Now assume that the COP rate of annual depreciation doesn’t follow parity conditions. What is the break- even rate of depreciation in COP? Assuming the USD inflation is unchanged, what is the COP inflation rate consistent with this break- even depreciation?

Answer 1

								(All figures in COP)
		(Conversion Rate 1USD = 2782 COP)
		Period	0	1	2	3	4	5
		Investment	21750,00,000
		Profit & Loss Account
		Revenue		10325,00,000	10634,75,000	10953,79,250	11282,40,628	11620,87,846
		Less : Direct Expenses		4200,00,000	4494,00,000	4808,58,000	5145,18,060	5505,34,324
		Less : Indirect Expenses		750,00,000	750,00,000	750,00,000	750,00,000	750,00,000
		Gross Profit		5375,00,000	5390,75,000	5395,21,250	5387,22,568	5365,53,522
		Less : Depreciation		4350,00,000	4350,00,000	4350,00,000	4350,00,000	4350,00,000
		PBT		1025,00,000	1040,75,000	1045,21,250	1037,22,568	1015,53,522
		Less : Taxes		338,25,000	343,44,750	344,92,013	342,28,447	335,12,662
		PAT		686,75,000	697,30,250	700,29,238	694,94,120	680,40,860
a		Cash Flows
		Period	0	1	2	3	4	5
		Outflows
		Investment	21750,00,000
		Tax	-	338,25,000	343,44,750	344,92,013	342,28,447	335,12,662
		Working Capital		1800,00,000				-1800,00,000
		Total Cash Outflows	21750,00,000	2138,25,000	343,44,750	344,92,013	342,28,447	-1464,87,338
		Inflows
		Salvage Value						120,00,000
		PAT		686,75,000	697,30,250	700,29,238	694,94,120	680,40,860
		Add : Depreciation		4350,00,000	4350,00,000	4350,00,000	4350,00,000	4350,00,000
		Total Cash Inflows	-	5036,75,000	5047,30,250	5050,29,238	5044,94,120	5150,40,860
		Net Inflows	-21750,00,000	2898,50,000	4703,85,500	4705,37,225	4702,65,673	6615,28,198
b		NPV (In COP)
		Discount Factor = (1+WACC)/(1+Inflation) = (1.125/1.06)
		Disc factor =	1.061320755
		NPV (@ 1.06132 as discount factor)
			-8859,06,346	COP
c		NPV (in USD)
		Discount Factor = (1+WACC)/(1+Inflation) = (1.125/1.06)
		Disc Factor =	1.097560976
		NPV (@ 1.09756 as discount factor)
			-8764,14,551	USD
d		Break Even Sales
		At Break Even PBT = 0
		Contribution margin = Sales   - Variable Expenses
			=	599000-240000
		Fixed expenses	750,00,000
		Depreciation	4350,00,000
					1420.612813
		At Break Even , Contribution Margin = Fixed Expenses + Depreciation
			(599000-240000)*n = 75000000+435000000
			n = 1420

Disc Factor =