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.

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

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

Tax rate		30%
Calculation of annual depreciation
Depreciation		Year-1	Year-2	Year-3	Year-4	Year-5	Total
Depreciable cost		€          1,500,000	€     1,500,000	€    1,500,000	€        1,500,000	€     1,500,000
Dep Rate		20.00%	20.00%	20.00%	20.00%	20.00%
Depreciation	Cost * Dep rate	€             300,000	€        300,000	€       300,000	€           300,000	€        300,000	€        1,500,000
Calculation of after-tax salvage value
Cost of machine			€     1,500,000
Depreciation			€     1,500,000
WDV	Cost less accumulated depreciation	€                  -
Sale price			€        500,000
Profit/(Loss)	Sale price less WDV	€        500,000
Tax	Profit/(Loss)*tax rate	€        150,000
Sale price after-tax	Sale price less tax		€        350,000
Calculation of annual operating cash flow
		Year-1	Year-2	Year-3	Year-4	Year-5
Sale		€             600,000	€        600,000	€       600,000	€           600,000	€        600,000
Less: Operating Cost		€             150,000	€        150,000	€       150,000	€           150,000	€        150,000
Contribution		€             450,000	€        450,000	€       450,000	€           450,000	€        450,000
Less: Depreciation		€             300,000	€        300,000	€       300,000	€           300,000	€        300,000
Profit before tax (PBT)		€             150,000	€        150,000	€       150,000	€           150,000	€        150,000
Tax@30%	PBT*Tax rate	€               45,000	€          45,000	€         45,000	€             45,000	€          45,000
Profit After Tax (PAT)	PBT - Tax	€             105,000	€        105,000	€       105,000	€           105,000	€        105,000
Add Depreciation	PAT + Dep	€             300,000	€        300,000	€       300,000	€           300,000	€        300,000
Cash Profit after-tax		€             405,000	€        405,000	€       405,000	€           405,000	€        405,000
Calculation of NPV
						12.00%
Year		Capital	Working capital	Operating cash	Annual Cash flow	PV factor, 1/(1+r)^time	Present values
0		€        (1,500,000)	€      (100,000)		€      (1,600,000)	1.0000	€      (1,600,000)
1				€       405,000	€           405,000	0.8929	€           361,607
2				€       405,000	€           405,000	0.7972	€           322,864
3				€       405,000	€           405,000	0.7118	€           288,271
4				€       405,000	€           405,000	0.6355	€           257,385
5		€             350,000	€        100,000	€       405,000	€           855,000	0.5674	€           485,150
					Net Present Value	€           115,276
EURO NPV	€            115,276
Spot rate	$                  1.35
NPV in USD=	115276*1.35
NPV in USD=	$            155,623