Question
In: Accounting
4. Spartan Inc. (a US based MNC) is planning to open a subsidiary in Switzerland to...
4. Spartan Inc. (a US based MNC) is planning to open a subsidiary in Switzerland to manufacture shoes. The new plant will cost SF 1.0 billion. The salvage value of the plant at the end of the 4 yr economic life is estimated to be SF 200 million net of any tax effects. This plant will also call for extra inventory holding of SF 300 million, and extra accounts payables of SF 200 million. Projected sales from this new plant are SF 800 million per year. The fixed costs are estimated to be SF 300 million per year, and the variable costs are estimated to be SF 100 million per year. Depreciation on the new plant after accounting for the salvage value will be SF 300 million per year. The Swiss government will impose a 40 % tax on the earnings. US govt. will not impose any taxes. 100 % of the cash flows will be remitted to the parent. The exchange rate is expected to be stable at $ 0.80 per SF. Spartan requires 15 % return on its capital investments.
Please compute:
a) Net Investment Cost of the plant
b) Cash flows in years 1 through 4 of the project
c) Net Present Value of the project
d) Internal Rate of Return (IRR) of the project
e) Should the project be accepted or rejected? Why or why not?
f) If the exchange rate scenario unfolds as follows
t = time 0 1 2 3 4
$0.80/SF $0.70/SF $0.70/SF $0.65/SF $0.55/SF
Re-compute the NPV. Is the project still acceptable? Why or why not?
g) If the exchange rate scenario were to unfold as follows,
t=time 0 1 2 3 4
$0.80/SF $0.80/SF $0.90/SF $0.95/SF $1.00/SF
Re-compute the NPV. Is the project still acceptable? Why or why not?
Solutions
Expert Solution
| a) Net Investment Cost of the plant | ||||||
| New plant cost | 1,00,00,00,000 | |||||
| Plus additional working capital | ||||||
| Inventory | 30,00,00,000 | |||||
| Account payable | -20,00,00,000 | 10,00,00,000 | ||||
| Net investment | 1,10,00,00,000 | |||||
| b) Cash flows in years 1 through 4 of the project | ||||||
| Year | 0 | 1 | 2 | 3 | 4 | |
| Net investment - cost of the plant | -1,10,00,00,000 | - | - | - | - | |
| Projected sale of new plant | 80,00,00,000 | 80,00,00,000 | 80,00,00,000 | 80,00,00,000 | ||
| Fixed cost | -30,00,00,000 | -30,00,00,000 | -30,00,00,000 | -30,00,00,000 | ||
| variable cost | -10,00,00,000 | -10,00,00,000 | -10,00,00,000 | -10,00,00,000 | ||
| Depreciation | -30,00,00,000 | -30,00,00,000 | -30,00,00,000 | -30,00,00,000 | ||
| Profit before tax | 10,00,00,000 | 10,00,00,000 | 10,00,00,000 | 10,00,00,000 | ||
| Tax@40% | - | -4,00,00,000 | -4,00,00,000 | -4,00,00,000 | -4,00,00,000 | |
| Profit after tax | 6,00,00,000 | 6,00,00,000 | 6,00,00,000 | 6,00,00,000 | ||
| Add: Depreciation | 30,00,00,000 | 30,00,00,000 | 30,00,00,000 | 30,00,00,000 | ||
| Profit after tax before depreciation | 36,00,00,000 | 36,00,00,000 | 36,00,00,000 | 36,00,00,000 | ||
| Salvage value of plant | 20,00,00,000 | |||||
| Realisation of additional working capital | 10,00,00,000 | |||||
| Cash flow | -1,10,00,00,000 | 36,00,00,000 | 36,00,00,000 | 36,00,00,000 | 66,00,00,000 | |
| $ Cash flow @ $=0.80SF | -1,37,50,00,000 | 45,00,00,000 | 45,00,00,000 | 45,00,00,000 | 82,50,00,000 | |
| c) Net Present Value of the project | ||||||
| Discount rate@15% | ||||||
| Cash flow | -1,37,50,00,000 | 45,00,00,000 | 45,00,00,000 | 45,00,00,000 | 82,50,00,000 | |
| Discount factor | 1.000 | 0.870 | 0.756 | 0.658 | 0.572 | |
| Present value | -1,37,50,00,000 | 39,15,00,000 | 34,02,00,000 | 29,61,00,000 | 47,19,00,000 | |
| NPV of the project | 12,47,00,000 | |||||
| d) Internal Rate of Return (IRR) of the project | ||||||
| IRR of the project | 18.978% | |||||
| e) Should the project be accepted or rejected? Why or why not? | ||||||
| NPV of the project is positive $124,700,000 @discount factor of 15%. Therefore project will be accepted. | ||||||
| f) If the exchange rate scenario unfolds as follows | ||||||
| t = time 0 1 2 3 4 | ||||||
| $0.80/SF $0.70/SF $0.70/SF $0.65/SF $0.55/SF | ||||||
| Exchange rate | 0.800 | 0.700 | 0.700 | 0.650 | 0.550 | |
| Cash flow | -1,37,50,00,000 | 51,42,85,714 | 51,42,85,714 | 55,38,46,154 | 1,20,00,00,000 | |
| Discount factor | 1.000 | 0.870 | 0.756 | 0.658 | 0.572 | |
| Present value | -1,37,50,00,000 | 44,74,28,571 | 38,88,00,000 | 36,44,30,769 | 68,64,00,000 | |
| NPV of the project | 51,20,59,341 | |||||
| Positive NPV, hence project is acceptable. | ||||||
| g) If the exchange rate scenario were to unfold as follows, | ||||||
| t=time 0 1 2 3 4 | ||||||
| $0.80/SF $0.80/SF $0.90/SF $0.95/SF $1.00/SF | ||||||
| Re-compute the NPV. Is the project still acceptable? Why or why not? | ||||||
| Exchange rate | 0.800 | 0.800 | 0.900 | 0.950 | 1.000 | |
| Cash flow | -1,37,50,00,000 | 45,00,00,000 | 40,00,00,000 | 37,89,47,368 | 66,00,00,000 | |
| Discount factor | 1.000 | 0.870 | 0.756 | 0.658 | 0.572 | |
| Present value | -1,37,50,00,000 | 39,15,00,000 | 30,24,00,000 | 24,93,47,368 | 37,75,20,000 | |
| NPV of the project | -5,42,32,632 | |||||
| Negative NPV, hence project is not acceptable. | ||||||
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