Download Chapter 6 International Investment and Financing Decisions

[Session 5 & 6]
June 2016
Education Course Notes
ACCA P4
Advanced Financial Management
Session 5 and 6
Chapter 6
Patrick Lui
[email protected]
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ACCA
Education Class 3
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Education Course Notes
[Session 5 & 6]
Chapter 6 International Investment and Financing Decisions
LEARNING OBJECTIVES
1.
2.
3.
4.
5.
Assess the impact upon the value of a project of alternative exchange rate
assumptions.
Forecast project or organization free cash flows in any specific currency and
determine the project’s net present value or organization value under differing
exchange rate, fiscal and transaction cost assumptions.
Evaluate the significance of exchange controls for a given investment decision and
strategies for dealing with restricted remittance.
Assess the impact of a project upon an organization’s exposure to translation,
transaction and economic risk.
Assess and advise upon the costs and benefits of alternative sources of finance
available within the international equity and bond markets.
International Investment
and
Financing Decisions
Effects of
Exchange Rate
NPV for
International
Projects
Forecasting Cash
Flows from
Overseas Project
Types of
Foreign Currency
Risk
Choosing Finance
for Overseas
Investment
Costs & Benefits
of Alternative
Sources of Finance
for MNCs
Purchasing
Power Parity
Calculating NPV
for International
Projects
Effect on
Exports
Transaction
Risk
Financing an
Overseas
Subsidiary
International
Borrowing
Interest Rate
Parity
Effect of
Exchange Rates
on NPV
Taxes
Economic
Risk
Choice of
Finance for an
Oveaseas
Investment
Syndicated
Loans
International
Fisher Effect
Inter-company
Cash Flows
Translation
Risk
Expectation
Theory
Remittance
Restrictions
Advantages of
Borrowing
Internationally
Risks of Borrowing
Internationally
Working
Capital
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[Session 5 & 6]
1.
Effects of Exchange Rate Assumptions on Project Values
1.1
Introduction
1.1.1 When a project in a foreign country is assessed, we must take into account some
specific considerations such as local taxes, double taxation agreements, and political
risk that affect the present value of the project.
1.1.2 The main consideration of course in an international project is the exchange rate risk,
that is the risk that arises from the fact that the cash flows are denominated in a
foreign country.
1.2
Purchasing power parity
(Dec 08, Dec 11, Dec 13)
1.2.1
Purchasing Power Parity
PPP claims that the rate of exchange between two currencies depends on the
relative inflation rates within the respective countries. In equilibrium, identical
goods must cost the same, regardless of the currency in which they are sold.
PPP predicts that the country with the higher inflation will be subject to a
depreciation of its currency.
Formally, if you need to estimate the expected future spot rates, PPP can be
expressed in the following formula:
S1 1  hc

S 0 1  hb
Where: S0 = Current spot rate
S1 = Expected future rate
hb = Inflation rate in country for which the spot is quoted (base country)
hc = Inflation rate in the other country (country currency).
Example 1
An item costs $3,000 in the US.
Assume that sterling and the US dollar are at PPP equilibrium, at the current spot rate of
$1.50/£, i.e. the sterling price x current spot rate of $1.50 = dollar price.
The spot rate is the rate at which currency can be exchanged today.
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The US market
Cost of item now
$3,000
Estimated inflation
Cost in one year
The UK market
$1.50
£2,000
5%
3%
$3,150
£2,060
The law of one price states that the item must always cost the same. Therefore in one
year:
$3,150 must equal £2,060, and also the expected future spot rate can be calculated:
$3,150 / £2,060 = $1.5291/£
By formula:
S1
1  5%

1.50 1  3%
S1  $1.5291
1.3
1.3.1
Interest rate parity
Interest Rate Parity (IRP)
The IRP claims that the difference between the spot and the forward exchange rates
is equal to the differential between interest rates available in the two currencies.
IRP predicts that the country with the higher interest rate will see the forward
rate for its currency subject to a depreciation.
If you need to calculate the forward rate in one year’s time:
F0 1  ic

S 0 1  ib
Where: F0 = Forward rate
S0 = Current spot rate
ib = interest rate for base currency
ic = interest rate for counter currency
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Example 2
UK investor invests in a one-year US bond with a 9.2% interest rate as this compares well
with similar risk UK bonds offering 7.12%. The current spot rate is $1.5/£.
When the investment matures and the dollars are converted into sterling, IRP states that the
investor will have achieved the same return as if the money had been invested in UK
government bonds.
In 1 year, £1.0712 million must equate to $1.638 million so what you gain in extra interest,
you lose on an adverse movement in exchange rates.
The forward rates moves to bring about interest rate parity amongst different currencies:
$1.638 ÷ £1.0712 = $1.5291
By formula:
F0
1  9.2%

1.5 1  7.12%
F0  $1.5291
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1.4
1.4.1
[Session 5 & 6]
International Fisher Effect
International Fisher Effect
According to the International Fisher effect, interest rate differentials between
countries provide an unbiased predictor of future changes in spot exchange
rates.
The currency of countries with relatively high interest rates is expected to
depreciate against currencies with lower interest rates, because the higher
interest rates are considered necessary to compensate for the anticipated currency
depreciation.
The International Fisher effect can be expressed as:
1  ic 1  h c

1  ib 1  hb
Where: ic = the nominal interest rate in country c
ib = the nominal interest rate in country b
hc = the inflation rate in country c
hb = the inflation rate in country b
Example 3
The nominal interest rate in the US is 5% and inflation is currently 3%. If inflation in the
UK is currently 4.5%, what is its nominal interest rate? Would the dollar be expected to
appreciate or depreciate against sterling?
Solution:
The dollar is the base currency.
1  ic
1  0.045

1  0.05 1  0.03
ic  6.5%
The dollar would be expected to appreciate against sterling as it has a lower interest rate.
According to the International Fisher effect, the currency of a country with a lower interest
rate will appreciate against the currency of a country with a higher interest rate.
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1.5
1.5.1
[Session 5 & 6]
Expectations theory
International Fisher Effect
The expectations theory claims that the current forward rate is an unbiased
predictor of the spot rate at that point in the future.
The formula for expectation theory is:
Spot
Spot

Forward Expected future spot
2.
NPV for International Projects,
(Dec 08, Dec 11, Dec 13, Jun15)
2.1
Calculating NPV for international projects
2.1.1 There are two alternative approaches for calculating the NPV from an overseas
project.
2.1.2 First approach:
(a)
Forecast foreign currency cash flows including inflation
(b)
Forecast exchange rates and therefore the home currency cash flows
(c)
Discount home currency cash flows at the domestic cost of capital
2.1.3 Second approach:
(a)
Forecast foreign currency cash flows including inflation
(b)
Discount at foreign currency cost of capital and calculate the foreign
currency NPV
(c)
Convert into a home currency NPV at the spot exchange rate
Example 4
ABC Inc, a US company, is considering undertaking a new project in the UK. This will
require initial capital expenditure of £1,250 million, with no scrap value envisaged at the
end of the five year lifespan of the project. There will also be an initial working capital
requirement of £500 million, which will be recovered at the end of the project. The initial
capital will therefore be £1,750 million. Pre-tax net cash inflows of £800 million are
expected to generate each year from the project.
Company tax will be charged in the UK at a rate of 40%, with depreciation on a straight-line
basis being an allowable deduction for tax purposes. Tax is paid at the end of the year
following that in which the taxable profits arise.
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There is a double taxation agreement between the US and UK, which means that no US tax
will be payable on the project profits.
The current spot rate is £0.625 = $1. Inflation rates are 3% in the US and 4.5% in the UK. A
project of similar risk recently undertaken by ABC Inc in the US had a required post-tax rate
of return of 10%.
Required:
Calculate the PV of the project using each of the two alternative approaches.
Solution:
Method 1 – convert sterling cash flows into $ and discount at $ cost of capital
Firstly we have to estimate the exchange rate for each of years 1 – 6. This can be done using
purchasing power parity.
£/$ expected spot rate
Year
1
0.625 × 1.045/1.03
0.634
2
0.634 × 1.045/1.03
0.643
3
0.643 × 1.045/1.03
0.652
4
0.652 × 1.045/1.03
0.661
5
0.661 × 1.045/1.03
0.671
6
0.671 × 1.045/1.03
0.681
0
£m
Pre-tax net cash flows
Tax paid
CA tax benefits (1,250 / 8 x 40%)
Capital investment
Working capital
Net cash flow
Exchange rate
Net cash flow in $m
Discount at 10%
PV
NPV =
Prepared by Patrick Lui
2
£m
800
(320)
100
3
£m
800
(320)
100
4
£m
800
(320)
100
5
£m
800
(320)
100
6
£m
(320)
100
800
580
580
580
500
1,080
(220)
0.625
0.634
0.643
0.652
0.661
0.671
0.681
(2,800)
1.000
(2,800)
1,262
0.909
1,147
902
0.826
745
890
0.751
668
877
0.683
599
1,610
0.621
1,000
(323)
0.564
(182)
(1,250)
(500)
(1,750)
1
£m
800
1,177
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Method 2 – discount sterling cash flows at adjusted cost of capital
When we use this method we need to find the cost of capital for the project in the host
country. If we are to keep the cash flows in £ they need to be discounted at a rate that takes
account of both the US discount rate (10%) and different rates of inflation in the two
countries. This is an application of the International Fisher effect.
1  ic 1  h c

1  ib 1  hb
1  ic
1  0.045
where ic is the UK discount rate

1  0.10 1  0.03
1 + ic = 1.116, therefore ic is approximately 12%
0
£m
Pre-tax net cash flows
Tax paid
CA tax benefits (1,250 / 8 x 40%)
Capital investment
Working capital
Net cash flow
Discount at 12%
PV
NPV in £m =
(1,250)
(500)
(1,750)
1.000
(1,750)
1
£m
800
2
£m
800
(320)
100
3
£m
800
(320)
100
4
£m
800
(320)
100
5
£m
800
(320)
100
6
£m
(320)
100
800
0.893
714
580
0.797
462
580
0.712
413
580
0.636
369
500
1,080
0.567
612
(220)
0.507
(112)
709
Translating this present value at the spot rate gives
NPV = £709 / 0.625 = $1,134m
Note that the two answers are almost identical (with differences being due to rounding). In
the first approach the dollar is appreciating due to the relatively low inflation rate in the US
(not good news when converting sterling to $). In the second approach the UK discount rate
is higher due to the relatively high inflation rate in the UK (again this is bad news as the
NPV of the project will be lower).
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2.2
[Session 5 & 6]
The effect of exchange rates on NPV
2.2.1 When there is a devaluation of the domestic currency relative to a foreign currency,
then the domestic currency value of the net cash flows increases and thus the NPV
increases.
2.2.2 The opposite happens when the domestic currency appreciates. In this case the
domestic currency value of the cash flows decline and the NPV of the project in home
currency declines.
3.
Forecasting Cash Flows from Overseas Project
3.1
Effect on exports
3.1.1 When a multinational company sets up a subsidiary in another country, to which it
already exports, the relevant cash flows for the evaluation of the project should take
into account the loss of export earnings in the particular country. The NPV of the
project should take explicit account of this potential loss.
3.2
Taxes
3.2.1 Taxes play an important role in the investment appraisal as it can affect the viability of
a project. The main aspects of taxation in an international context are:
(a)
Corporate taxes in the host country
(b)
Investment allowances in the host country
(c)
Withholding taxes in the host country
(d)
Double taxation relief in the home country
(e)
Foreign tax credits in the home country
Example 5 – Different tax rate in home and foreign countries
What will be the rate of tax on a project carried out in the US by a UK company in each of
the following scenarios?
(a)
(b)
(c)
UK tax
33%
33%
33%
<
=
>
US tax
40%
33%
25%
Solution:
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(a)
(b)
(c)
[Session 5 & 6]
No further UK tax to pay on the project’s $ profits. Profits taxed at 40% in the US.
No further UK tax to pay on the project’s $ profits. Profits taxes at 33% in the US.
Project’s profit would be taxed at 33% => 25% in the US and a further 8% tax payable
in the UK.
Example 6 – Withholding tax
ABC Inc is considering whether to establish a subsidiary in France at a cost of €20,000,000.
The subsidiary will run for four years and the net cash flows from the project are show
below.
Project 1
Project 2
Project 3
Project 4
Net cash flow (€)
3,600,000
4,560,000
8,400,000
8,480,000
There is a withholding tax of 10 percent on remitted profits and the exchange rate is
expected to remain constant at €1.50 = $1. At the end of the four year period the Slovenian
government will buy the plant for €12,000,000. The latter amount can be repatriated free of
withholding taxes.
If the required rate of return is 15 percent what is the present value of the projects?
Solution:
€
3,600,000 × 90% = 3,240,000
4,560,000 × 90% = 4,104,000
8,400,000 × 90% = 7,560,000
(8,480,000 × 90% + 12,000,000)
= 19,632,000
Remittance
$
2,160,000
2,736,000
DF at 15%
0.870
0.756
PV
$
1,879,200
2,068,416
5,040,000
0.658
3,316,320
13,088,000
0.572
7,486,336
14,750,272
Less:
Initial
investment
(€20,000,000 ÷ 1.5)
13,333,333
NPV
1,416,939
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[Session 5 & 6]
Example 7
ABC plc is considering whether to establish a subsidiary in the USA, at a cost of
$2,400,000. This would be represented by non-current assets of $2,000,000 and working
capital of $400,000. The subsidiary would produce a product which would achieve annual
sales of $1,600,000 and incur cash expenditures of $1,000,000 a year.
The company has a planning horizon of four years, at the end of which it expects the
realisable value of the subsidiary's fixed assets to be $800,000.
It is the company's policy to remit the maximum funds possible to the parent company at the
end of each year.
Tax is payable at the rate of 35% in the USA and is payable one year in arrears. A double
taxation treaty exists between the UK and the USA and so no UK taxation is expected to
arise.
Tax allowable depreciation is at a rate of 25% on a straight line basis on all non-current
assets. The tax allowable depreciation can first be claimed one year after the investment i.e.
at t1.
Because of the fluctuations in the exchange rate between the US dollar and sterling, the
company would protect itself against the risk by raising a eurodollar loan to finance the
investment. The company's cost of capital for the project is 16%.
Calculate the NPV of the project.
Solution:
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[Session 5 & 6]
0
$m
Annual sales
Cash expenditures
Tax paid at 35%
CA tax benefits (W1)
Capital investment
Working capital
Net cash flow
Discount at 16%
Present value
(2.000)
(0.400)
(2.400)
1.000
(2.400)
NPV =
1
$m
1.600
(1.000)
0.600
0.175
2
$m
1.600
(1.000)
0.600
(0.210)
0.175
3
$m
1.600
(1.000)
0.600
(0.210)
0.175
0.775
0.862
0.668
0.565
0.743
0.420
0.565
0.641
0.362
4
$m
1.600
(1.000)
0.600
(0.210)
0.175
0.800
0.400
1.765
0.552
0.974
5
$m
(0.210)
(0.280)
(0.490)
0.476
(0.233)
(0.209)
W1 CA tax benefiit
Year
WDV
$m
Tax rate Tax benefits
1-4
2.000 x 25% =
0.5
x 35% =
0.175
5
0.800
x 35% =
(0.280)
Realisable value = balancing charge
3.3
Inter-company cash flows
3.3.1 Inter-company cash flows, such as transfer prices, royalties and management
charges, can also affect the tax computations.
3.3.2 Although complex in reality, in the exam:
(a)
Assume inter-company cash flows are allowable for tax unless the question
says otherwise
(b)
If an inter-company cash flow is allowable for tax relief overseas, there will
be a corresponding tax liability on the income in the home country
Assume that the tax authorities will only allow arm’s length / open market
(c)
prices for tax relief and will not allow an artificially high or low transfer
price.
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[Session 5 & 6]
Example 8 – Double taxation and tax treatment of inter-company cash flows
A project carried out by a US subsidiary of a UK company is due to earn revenues of $100m
in the US in Year 2 with associated costs of $30m. Royalties payments of $10m will be
made by the US subsidiary to the UK. Assume tax is paid at 25% in the US and 33% in the
UK; and assume a forecast $/£ spot rate of $1.50/£.
Required:
Forecast the project’s cash flows in Year 2.
Solution:
Revenues
$m
100
Costs
Royalties
(30)
(10)
Pre-tax cash flow
25% US tax
60
(15)
Remit to parent
@ $/£ spot
45
÷ 1.5
£ cash flow
Royalties ($10m ÷ 1.5)
£30
£6.7
UK tax
8% UK tax on $ profits ($60m ÷ 1.5 × 8%)
33% UK tax on royalties (£6.7m × 33%)
£m
3.2
2.2
Total UK tax payable
5.4
3.4
Remittance restrictions
3.4.1 Remittance restrictions occur where a foreign government places a limit on the funds
that can be repatriated back to the holding company. This restriction may change the
cash flows that are received by the holding company.
3.4.2 The actual amount received by the parent company (and therefore the shareholders)
is the relevant cash flow for the NPV purposes.
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[Session 5 & 6]
Example 9 – Remittance restrictions
A project’s after-US tax $ cash flow is as follows ($m):
Year
0
(10)
1
3
2
4
3
6
In any one year, only 50% of cash flows generated can be remitted back to the parent. The
blocked funds can be released back to the parent in the year after the end of the project.
Required:
Identify the cash flows to be evaluated for NPV purposes.
Solution:
Cash flows to parent:
Year
Net cash flow
Blocked funds
Remit to parent
1
3
(1.5)
2
4
(2)
3
6
(3)
4
1.5
2
3
6.5
It is these remitted cash flows that have to be put through the NPV calculation.
3.4.3 Strategies for dealing with exchange controls
(a)
Management charges – levied by the parent company for costs incurred in
the management of the foreign operations.
(b)
Transfer pricing – on goods/services supplied by one member of a group to
another.
(c)
Royalty payments – imposed when the foreign subsidiary is granted the right
to make certain patented goods.
(d)
Loans – if the parent lends money to the foreign subsidiary, the interest rate
can be set at a level to ensure that the required amount of money is transferred
to the parent from the subsidiary.
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3.5
[Session 5 & 6]
Working capital
3.5.1 It is normally assumed that the working capital requirement for the foreign project
will increase by the annual rate of inflation in that country.
Example 10 – Working capital changes
Four million pesos in working capital are required immediately for a project running in
South America. The inflation rates for the next six years in the South American country are
expected to be:
Year
1
6%
2
4%
3
5%
4
4%
5
3%
6
4%
Required:
Identify the working capital flows for the NPV calculation.
Solution:
Working capital
Inflation
Total working capital
Changes in working capital
0
$000
4,000
1.00
4,000
(4,000)
1
$000
1.06
4,240
(240)
2
$000
1.04
4,410
(170)
4.
Types of Foreign Currency Risk
4.1
Currency risk
3
$000
1.05
4,630
(220)
4
$000
1.04
4,815
(185)
5
$000
1.03
4,960
(144)
6
$000
1.04
5,158
(198)
7
$000
5,158
4.1.1 Currency risk occurs in three forms: transaction exposure (short-term), economic
exposure (effect on present value of longer term cash flows) and translation
exposure (book gains or losses).
4.2
Transaction risk
(Dec 12)
4.2.1 Transaction risk is the risk of an exchange rate changing between the transaction
date and the subsequent settlement date, i.e. it is the gain or loss arising on
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conversion. It arises primarily on import and exports.
4.2.2 As transaction risk has a potential impact on the cash flows of a company, most
companies choose to hedge against such exposure. Measuring and monitoring
transaction risk is normally an important component of treasury management.
4.3
Economic risk
(Dec 12)
4.3.1 Economic risk is the variation in the value of the business (i.e. the present value of
future cash flows) due to unexpected changes in exchange rates. It is the long-term
version of transaction risk.
4.4
Translation risk
(Dec 12)
4.4.1 This is the risk that the organization will make exchange losses when the accounting
results of its foreign branches or subsidiaries are translated into the home
currency. Translation losses can result, for example, from restating the book value of
a foreign subsidiary’s assets at the exchange rate on the statement of financial position
date.
5.
Choosing Finance for Overseas Investment
5.1
Financing an overseas subsidiary
5.1.1 Large companies can borrow money in foreign currencies as well as their own
domestic currency from banks or capital markets at home or abroad. Often large
companies set up foreign subsidiaries to invest in foreign projects and arrange the
financing.
5.1.2 The main reason for wanting to borrow in a foreign currency is to fund a foreign
investment project or foreign subsidiary. The foreign currency borrowing provides
a hedge of the value of the project or subsidiary to protect against changes in
value due to currency movements.
5.2
Choice of finance for an overseas investment
5.2.1 The choice of the source funds will depend on:
(a)
(b)
The local finance costs, and any subsidies which may be available
Taxation systems of the countries in which the subsidiary is operating.
Different tax rates can favour in high tax regimes, and no borrowing elsewhere
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(c)
[Session 5 & 6]
Any restrictions on dividend remittances
(d)
The possibility of flexibility in repayments which may arise from the parent /
subsidiary relationship
5.2.2 Parent companies should also consider the following factors:
(a)
Reduced systematic risk – There may be a small incremental reduction in
systematic risk from investing abroad due to the segmentation of capital
markets.
(b)
Access to capital – Obtaining capital from foreign markets may increase
liquidity, lower costs and make it easier to maintain optimum gearing.
(c)
Agency costs – These may be higher due to political risk, market
imperfections and complexity, leading to a higher cost of capital.
6.
Costs and Benefits of Alternative Sources of Finance for MNCs
6.1
International borrowing
6.1.1 Borrowing markets are becoming increasingly internationalized, particularly for larger
companies.
6.1.2 Companies are able to borrow long-term funds on the Eurocurrency (money)
markets and on the markets for Eurobonds. These markets are collectively called
Euromarkets.
6.1.3 Large companies can also borrow on the syndicated loan market where a syndicate of
banks provides medium to long-term currency loans.
6.1.4 If a company is receiving income in a foreign currency or has a long-term
investment overseas, it can try to limit the risk of adverse exchange rate
movements by matching. It can take out a long-term loan and use the foreign
currency receipts to repay the loan.
6.2
Syndicated loans
(Dec 08, Dec 09)
6.2.1 A syndicated loan is a loan put together by a group of lenders (a ‘syndicate’) for a
single borrower.
6.2.2 Banks or other institutional lenders may be unwilling (due to excessive risk) or unable
to provide the total amount individually but may be willing to work as part of a
syndicate to supply the requested funds.
6.2.3 Given that many syndicated loans are for very large amounts, the risk of even one
single borrower defaulting could be disastrous for an individual lender. Sharing the
risk is likely to be more attractive for investors.
Prepared by Patrick Lui
P. 180
Copyright @ Kaplan Financial 2016
Education Course Notes
[Session 5 & 6]
6.2.4 Originally syndicated loans were limited to international organisations for acquisitions
and other investments of similar importance and amounts. This was mainly due to the
following:
(a)
Elimination of foreign exchange risk – borrowers may be able to reduce
exchange rate risk by spreading the supply of funds between a number of
different international lenders.
(b)
Speed – in normal circumstances it may take some time to raise very large
amounts of money. The efficiency of the syndicated loans market means that
large loans can be put together very quickly.
6.3
Advantages of borrowing internationally
6.3.1 There are three main advantages from borrowing for international capital markets, as
opposed to domestic capital markets:
6.4
(a)
Availability. Domestic financial markets, with the exception of the large
countries and the Euro zone, lack the depth and liquidity to accommodate
either large debt issues or issues with long maturities.
(b)
Lower cost of borrowing. In Eurobond markets interest rates are normally
lower than borrowing rates in national markets
(c)
Lower issue costs. The cost of debt issuance is normally lower than the cost
of debt issue in domestic markets.
Risks of borrowing internationally
6.4.1 A multinational company has three options when financing an overseas project by
borrowing.
(a)
(b)
(c)
The first is to borrow in the same currency as the inflows from the project.
The second option is borrowing in a currency other than the currency of
the inflows but with a hedge in place and
The third option is borrowing in a currency other than the currency of the
inflows but without hedging the currency risk. The last case exposes the
company to exchange rate risk which can substantially change the
profitability of a project.
Prepared by Patrick Lui
P. 181
Copyright @ Kaplan Financial 2016
Education Course Notes
[Session 5 & 6]
Examination Style Questions
Question 1
Donegal plc manufactures Irish souvenirs. These souvenirs are exported in vast quantities to
the USA to the extent that Donegal is considering setting up a manufacturing and commercial
subsidiary there. After undertaking research, it has been found that it would cost $6m,
comprising $5m in non-current assets and $1m in working capital. Annual sales of the
souvenirs have been estimated as $4m and they would cost $2.5m per annum to produce.
Other costs are likely to be $300,000 per annum.
Tax rate are as follows.
Ireland
23%
USA
25%
Tax is payable in the year of occurrence in both countries. Assume there is no double tax
relief.
Capital allowances at a rate of 20% reducing balance are available. Balancing allowances or
balancing charges should also be accounted for at the end of the project’s life.
The maximum possible funds will be remitted to the home country (Ireland) at the end of
each year. The exchange rate is €0.71 = $1. It is assumed that this rate will remain constant
over the project’s life.
The project is being appraised on a five year time span. The non-current assets will be sold
for an expected $2.5m at the end of the project’s life.
Donegal uses a cost of capital of 12% on all capital investment projects.
Required:
Calculate the NPV of the proposed project and recommend to the Board of Directors of
Donegal whether the US subsidiary should be set up.
Prepared by Patrick Lui
P. 182
Copyright @ Kaplan Financial 2016