Question

Flexible Steel of the United States is considering expanding its business in Zaire. Under current law, 100% of foreign investor cash flow from depreciation and 50% of accounting income must be retained within Zaire until the investment is 5 years old. Blocked funds may be reinvested in treasury deposits at 5% per annum, tax free, and compounded annually. Flexible Steel is contemplating a new steel plant investment as follows. All cash flows will be valued if they occur on December 31. Thus the investment outlay occurs on December 31, 2020, and earnings are available for local currency dividend payments on December 31, 2021 through 2025. All blocked funds may be exchanged for dollars on December 31, 2025. Foreign exchange rates are expected to be as follows:

December 31, 2018: Z 4.0/$

December 31, 2019: Z 4.5/$

December 31, 2020: Z 5.0/$

December 31, 2021: Z 5.5/$

December 31, 2022: Z 6.0/$

December 31, 2023: Z 6.5/$

Other information includes the following: * Investment outlay will be $40,000,000 for plant and equipment and $4,000,000 for working capital. * Recovery for building and equipment will be depreciated on a straight-line basis over 5 years to a zero salvage value. Working capital will be fully recovered at the end of five years. * Sales are expected to be Z100,000,000 per year. Variable cash costs will be 30% of sales, and fixed cash costs will be Z3,000,000 annually. * Corporate income taxes are 30% in both Zaire and the United States. * Flexible Steel's weighted average cost of capital for projects of this type is 15%. In similar projects would be expected to earn 15%. Calculate the NPV of the project based on cash flows to the parent.

A)$16,285,500 loss

B) $11,673,700 loss
C) $20,349,300 loss

D) $18,432,400 loss

E) $14,196,800 loss

Answer 1

		Present Value(PV) of Cash Flow:
		(Cash Flow)/((1+i)^N)
		i=discount rate =15%=0.15
		N=Year   of Cash Flow
		Investment in Zaire:
		Plant and equipment=40*4.0=	160	(Z million)
		Working Capital=4*4=	16	(Z million)
		CASH FLOW ANALYSIS OF THE PROJECT
			DEc31,2018	DEc31,2019	DEc31,2020	DEc31,2021	DEc31,2022	DEc31,2023
	N	Year	0	1	2	3	4	5
	a	Cash Flow for fixed asset investment(Z million)	(160.00)
	b	Initial cash flow for working capital(Z million)	(16.00)
	C=a+b	Total initial cash flow(Z million)	(176.00)
	d	Annual Sales(Z million)		100.00	100.00	100.00	100.00	100.00
	e=d*30%	Variable Costs(Z million)		(30.00)	(30.00)	(30.00)	(30.00)	(30.00)
	f	Fixed Costs(Z million)		(3.00)	(3.00)	(3.00)	(3.00)	(3.00)
	g	Annual Depreciation expense (160/5)(Z million)		(32.00)	(32.00)	(32.00)	(32.00)	(32.00)
	h=d+e+f+g	Before tax operating profit(Z million)		35.00	35.00	35.00	35.00	35.00
	i=-h*30%	Tax Expenses(Z million)		(10.50)	(10.50)	(10.50)	(10.50)	(10.50)
	j=h+i	After tax Accounting profit(Z million)		24.50	24.50	24.50	24.50	24.50
	j	Add depreciation expenses(non cash)(Z million)		32.00	32.00	32.00	32.00	32.00
	K=i+j	Annual Operating Cash Flow(Z million)		56.50	56.50	56.50	56.50	56.50
	m	Release of initial working capital(Z million)						16.00
	CF=C+K+m	Net Cash Flow(Z million)	(176.00)	56.50	56.50	56.50	56.50	56.50
	X=j*50%	Amount retained from after tax accounting profit		28.25	28.25	28.25	28.25
	Y=j*30%	Depreciation tax shield Retained		9.60	9.60	9.60	9.60
	Z=X+Y	Total Blocked Fund		37.85	37.85	37.85	37.85
	P=CF-Z	Net Cash Flow to parent after deducting blocked fund	(176.00)	18.65	18.65	18.65	18.65	56.50
	Q	Future Value of Blocked Fund at end of Year5						171.30	(37.85*((1.05^4)+(1.05^3)+(1.05^2)+1.05)
	R=P+Q	Net Cash Flow to Parent (Z million)	(176.00)	18.65	18.65	18.65	18.65	227.80
	S	Foreign Exchange Rate(Z/$)	4.00	4.50	5.00	5.50	6.00	6.50
	T=R/S	Net Cash Flow to Parent ($ million)	($44.0000000)	$4.1444444	$3.7300000	$3.3909091	$3.1083333	$35.0454066	SUM
	PV=T/(1.15^N)	Present Value of Net Cash Flow to Parent ($ million)	($44.0000000)	$3.6038647	$2.8204159	$2.2295778	$1.7771997	$17.4237608	($16.1451811)
		Net Present Value =Sum of PV=	($16,145,181.11)
		ANSWER IS NEAREST TO
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