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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