Question

The Wheel Deal Inc., a company that produces scooters and other wheeled non-motorized recreational equipment is considering an expansion of their product line to Europe. The expansion would require a purchase of equipment with a price of €1,200,000 and additional installation of €300,000 (assume that the installation costs cannot be expensed, but rather, must be depreciated over the life of the asset). Because this would be a new product, they will not be replacing existing equipment. The new product line is expected to increase revenues by €600,000 per year over current levels for the next 5 years, however; expenses will also increase by €150,000 per year. (Note: Assume the after-tax operating cash flows in years 1-5 are equal, and that the terminal value of the project in year 5 may change total after-tax cash flows for that year.) The equipment is multipurpose, and the firm anticipates that they will sell it at the end of the five years for €500,000. The firm's required rate of return is 12% and they are in the 30% tax bracket. Depreciation is straight-line to a value of €0 over the 5-year life of the equipment, and the initial investment (at year 0) also requires an increase in NWC of €100,000 (to be recovered at the sale of the equipment at the end of five years). The current spot rate is $1.350/€, and the expected inflation rate in the U.S. is 4% per year and 3% per year in Europe.

1)Refer to the text block above. In euros, what is the NPV of the Wheel Deal expansion?

2)The expected inflation rate in the U.S. is 4% per year and 3% per year in Europe. What is the NPV of a European project if Scepter Corporation computes the NPV in euros as €100,000 and then converts that figure to dollars using the current spot rate of $1.350/€?

Answer 1

Given

Purchase price of equipment = 1,200,000 Euros

Additional Installation Expenses = 300,000 Euros

Increase in Net Working Capital = 100,000 Euros

Terminal Value = 500,000 Euros

Expected Life of the Asset = 5 Years

Rate of Return = 12%

(1)

TOTAL COST OF INVESTMENT = 1,200,000 + 300,000 + =1,500,000 Euros

Depreiation should be calculated on Total Cost of Investment over 5 years Under Straight Line Method

Depriciation Formula = (Total Cost of Investment - Terminal Value ) / Expected Life of the Asset

= (1,500,000 - 500,000) / 5

= 200,000 Euros

PARTICULARS	AMOUNT (IN EUROS)
Increase in Revenue	600,000
Less : Increase in Expenses	-100,000
EBITDA	500,000
Less Depreciaiton	-200000
EBIT	300,000
Less: Interest	0
PBT	300,000
Less: Taxes @30%	-90000
PAT	210,000

CALCULATION OF CASHFLOWS
PARTICULARS	AMOUNT(IN EUROS)
PAT	210,000
Add: Non Cash Expenditure	200000
CASH FLOW	410,000

It is assumed that every year after tax cash flow will be same. Hence, CASH FLOW TILL YEAR 5 WILL BE SAME.

There will be recovery of Networking Capital in the 5th year and it is an expenditure at the zeroth year.

	AMOUNT (IN EUROS)
PARTICULARS	YEAR 0	YEAR 1	YEAR 2	YEAR 3	YEAR 4	YEAR 5
Investment
Cost of Equipment	-1500000
Networking Capital	-100000
TOTAL COST	-1600000
AFTER TAX CASH FLOWS		410,000	410,000	410,000	410,000	410,000
Netwroking capital recoverred						100000
Terminal Value of Equipment						500000
						1,010,000
Dsicount Factor@12%	1	0.892857143	0.797193878	0.711780248	0.635518078	0.567427
PRESESNT VALUE OF CASHFLOWS	-1600000	366071.4286	326849.4898	291829.9016	260562.4121	573101.1
NET PRESENT VALUE (IN EUROS)	218414.

(2)

Given

NPV by SCEPTOR CORPORATION IN EUROS = 100,000 Euros

1 Euro = 1.350 Dollars

NPV in Dollars = 100,000 * 1.350

= 135,000 Dollars

NPV = 135,000 Dollars