4. Wilmington Inc. is considering the acquisition of a unit from the French government. • Initial...

4. Wilmington Inc. is considering the acquisition of a unit from the French government.

• Initial outlay will be $4 million dollars

• All earnings reinvested

• Time period 8 years and at that time will sell acquisition for 12 million euros after taxes

• Spot rate for euro is $1.20

• Risk free U.S. intersect rate regardless of maturity is 5 percent

• Risk free interest rate on euros regardless of maturity is 7 percent

• Interest rate parity holds

• Cost of capital is 20 percent

• Cash will be used for acquisition

a. Using the parameters above, Determine the NPV.

b. Rather than use all cash, Wilmington Inc. could partially finance the acquisition. It could obtain a loan of 3 million euros today that would be used to cover a portion of the acquisition. In this case, it would have to pay back a lump sum total of 7 million euros at the end of 8 years to repay the loan. There are no interest payments on this debt. This financing deal is structured such that none of the payment is tax-deductible. Determine the NPV if Wilmington uses the forward rate instead of the spot rate to forecast the future spot rate of the euro, and elects to partially finance the acquisition.

Solutions

Expert Solution

Year	0	8
Rate	$1.20	$ 1.032
Cash Flows	-$ 4.00	€ 12.00
CF ($)	-$ 4.00	$ 12.38
NPV ($)	-$ 1.12

Let's forecast the exchange rate in 8 years using interest rate parity

Future Rate = Spot Rate x ((1 + US rate) / (1 + euro rate))^n = 1.20 x (1.05 / 1.07)^8 = 1.032 dollar per euro

Cash Flows in dollars after 8 years = 12 x 1.032 = 12.38

NPV = 12.38 / (1 + 20%)^8 - 4 = - $ 1.12 million

Year	0	8
Rate	$1.20	$ 1.032
Loan	€ 3.00	€ 7.00
Cash Flows	-$ 4.00	€ 12.00
Net CF ($)	-$ 0.40	$ 5.16
NPV ($)	$ 0.80

In this case, net cash flow in year 0 = -4 + 3 x 1.2 = -0.40 million

Net cash flow in year 8 = 1.032 x (12 - 7) = $5.16 million

NPV = 5.16 / (1 + 20%)^8 - 0.40 = $0.80 million

jeff jeffy answered 1 year ago

Next > < Previous

Related Solutions

The government is considering imposing a new law to improve health that French fries have to...

The government is considering imposing a new law to improve health that French fries have to be sold for at least $4. (this question is unrelated to part A) -In order to be binding would this be a ceiling or floor? -Use a supply and demand graph to explain the impact of this policy. Use both positive and normative analysis and describe the pros and cons of the policy.

4. The management of Bronco Busters Boots Inc. is considering a project with a net initial...

4. The management of Bronco Busters Boots Inc. is considering a project with a net initial outlay of $60,000 and an annual net cash inflow estimated at $17,500 over the project's life of 5 years. The project has a cost of capital of 8 percent. What is the project's NPV? Question 4 options: A) $53,821 B) $9,872 C) −$109 D) $19,891

Simmons, Inc., is considering a new 4-year project that requires an initial fixed asset investment of...

Simmons, Inc., is considering a new 4-year project that requires an initial fixed asset investment of $3.7 million. The fixed asset is eligible for 100 percent bonus depreciation in the first year. At the end of the project, the asset can be sold for $465,000. The project is expected to generate $3.3 million in annual sales, with annual expenses of $980,000. The project will require an initial investment of $515,000 in NWC that will be returned at the end of...

Simmons, Inc., is considering a new 4-year project that requires an initial fixed asset investment of...

Simmons, Inc., is considering a new 4-year project that requires an initial fixed asset investment of $3.1 million. The fixed asset is eligible for 100 percent bonus depreciation in the first year. At the end of the project, the asset can be sold for $425,000. The project is expected to generate $2.9 million in annual sales, with annual expenses of $940,000. The project will require an initial investment of $475,000 in NWC that will be returned at the end of...

Simmons, Inc., is considering a new 4-year project that requires an initial fixed asset investment of...

Simmons, Inc., is considering a new 4-year project that requires an initial fixed asset investment of $3.5 million. The fixed asset is eligible for 100 percent bonus depreciation in the first year. At the end of the project, the asset can be sold for $445,000. The project is expected to generate $3.1 million in annual sales, with annual expenses of $960,000. The project will require an initial investment of $495,000 in NWC that will be returned at the end of...

Simmons, Inc., is considering a new 4-year project that requires an initial fixed asset investment of...

Simmons, Inc., is considering a new 4-year project that requires an initial fixed asset investment of $2.7 million. The fixed asset is eligible for 100 percent bonus depreciation in the first year. At the end of the project, the asset can be sold for $385,000. The project is expected to generate $2.5 million in annual sales, with annual expenses of $900,000. The project will require an initial investment of $435,000 in NWC that will be returned at the end of...

Simmons, Inc., is considering a new 4-year project that requires an initial fixed asset investment of...

Simmons, Inc., is considering a new 4-year project that requires an initial fixed asset investment of $3.65 million. The fixed asset is eligible for 100 percent bonus depreciation in the first year. At the end of the project, the asset can be sold for $460,000. The project is expected to generate $3.25 million in annual sales, with annual expenses of $975,000. The project will require an initial investment of $510,000 in NWC that will be returned at the end of...

Simmons, Inc., is considering a new 4-year project that requires an initial fixed asset investment of...

Simmons, Inc., is considering a new 4-year project that requires an initial fixed asset investment of $2.65 million. The fixed asset is eligible for 100 percent bonus depreciation in the first year. At the end of the project, the asset can be sold for $395,000. The project is expected to generate $2.45 million in annual sales, with annual expenses of $950,000. The project will require an initial investment of $420,000 in NWC that will be returned at the end of...

Plantation Homes Company is considering the acquisition of Condominiums, Inc. early in 2015.

Plantation Homes Company is considering the acquisition of Condominiums, Inc. early in 2015. To assess the amount it might be willing to pay, Plantation Homes makes the following computations and assumptions. A. Condominiums, Inc. has identifiable assets with a total fair value of $16,118,000 and liabilities of $9,099,000. The assets include office equipment with a fair value approximating book value, buildings with a fair value 29% higher than book value, and land with a fair value 74% higher than book value....

Vandezande Inc. is considering the acquisition of a new machine that costs $435,000 and has a...

Vandezande Inc. is considering the acquisition of a new machine that costs $435,000 and has a useful life of 5 years with no salvage value. The incremental net operating income and incremental net cash flows that would be produced by the machine are (Ignore income taxes.): Incremental Net Operating Income Incremental Net Cash Flows Year 1 $ 76,000 $ 155,000 Year 2 $ 82,000 $ 161,000 Year 3 $ 93,000 $ 175,000 Year 4 $ 56,000 $ 158,000 Year 5...

Subjects