FINANCE 6367- A U.S.-based firm is considering a five- year project in Colombia

FINANCE 6367- A U.S.-based firm is considering a five- year project in Colombia

FINANCE 6367- A U.S.-based firm is considering a five- year project in Colombia

Subject: Business    / Finance    

Question

Chapter 8

A U.S.-based firm is considering a five- year project in Colombia. The following information is available about the project: Initial investment. The initial investment of USD 900,000 is used to purchase capital equipment. This equipment will be depreciated straight line to zero. At the end of five years, the remaining equipment will be sold for Colombian Peso (COP) 200,000,000. Working capital. The investment in working capital is COP 220,000,000. There are no changes in working capital until the end of the project when the full amount is recovered. Units, price, and costs. The firm will produce 1,250 units of a product annually. The selling price is expected to be COP 700000 in the first year. This price is expected to increase at a rate of 5 percent annually. The direct expense per unit is expected to be COP 200000 in the first year. This is expected to increase at a rate of 8 percent annually. Indirect expenses are expected to be COP 80,000,000 annually.Taxes and miscellaneous. Colombian taxes on income and capital gains are 35 percent. There are no additional withholding taxes. All cash flows are repatriated when generated, and there are no additional U. S. taxes. The parity conditions are assumed to

hold between Colombia and the United States. The relevant inflation indexes indicate a rate of 3 percent for the United States and 8 percent for Colombia.

Spot USDCOP equals 3000. Brady’s USD denominated WACC is 12 percent.

a.

Calculate COP cash flows.

b.

What is the appropriate COP discount rate? Calculate the project NPV.

c.

Use parity conditions to generate future spot rates. Calculate the project NPV in USD.

d.

Calculate break- even units.

e.

Now assume that the COP rate of annual depreciation doesn’t follow parity conditions.

What is the break- even rate of depreciation in COP? Assuming the USD inflation is unchanged, what is the COP inflation rate consistent with this break- even depreciation?