13. Capital Budgeting Example. Brower, Inc. just constructed a manufacturing plant in Ghana.

The construction cost 9 billion Ghanian cedi. Brower intends to leave the plant open for three years. During the three years of operation, cedi cash flows are expected to be 3 billion cedi, 3 billion cedi, and 2 billion cedi, respectively. Operating cash flows will begin one year from today and are remitted back to the parent at the end of each year. At the end of the third year, Brower expects to sell the plant for 5 billion cedi. Brower has a required rate of return of 17 percent. It currently takes 8,700 cedi to buy one U.S. dollar, and the cedi is expected to depreciate by 5 percent per year. a. Determine the NPV for this project. Should Brower build the plant? b. How would your answer change if the value of the cedi was expected to remain unchanged from its current value of 8,700 cedis per U.S. dollar over the course of the three years? Should Brower construct the plant then?

20. Capital Budgeting Analysis. A project in South Korea requires an initial investment of 2 billion South Korean won. The project is expected to generate net cash flows to the subsidiary of 3 billion and 4 billion won in the two years of operation, respectively. The project has no salvage value. The current value of the won is 1,100 won per U.S. dollar, and the value of the won is expected to remain constant over the next two years. a. What is the NPV of this project if the required rate of return is 13 percent? b. Repeat the question, except assume that the value of the won is expected to be 1,200 won per U.S. dollar after two years. Further assume that the funds are blocked and that the parent company will only be able to remit them back to the U.S. in two years. How does this affect the NPV of the project?

Answers # 13 a. Determine the NPV for this project. Should Brower build the plant?

ANSWER: Cash Flows: Year Investment Operating CF Salvage Value Net CF Exchange rate Cash flows to parent PV of parent cash flows NPV 0 9 9 8,700 $1,034,483 $1,034,483 $1,034,483 1 3 3 9,135 $328,407.23 $280,689.94 $753,793.06 2 3 3 9,592 $312,760.63 $228,475.88 $525,317.18 3 2 5 7 10,071 $695,065.04 $433,978.15 $91,339.03

Since the project has a negative net present value (NPV), Brower should not undertake it. b. How would your answer change if the value of the cedi was expected to remain unchanged from its current value of 8,700 cedis per U.S. dollar over the course of the three years? Should Brower construct the plant then?

Answers # 20

ANSWER: Year Investment Operating CF Net CF Exchange rate Cash flows to parent PV of parent cash flows NPV The NPV is $3,443,139.99. 0 2 2 1,100 $1,818,181.82 $1,818,181.82 $1,818,181.82 3 3 1,100 $2,727,272.73 $2,413,515.69 +$595,333.87 1,100 $3,636,363.64 $2,847,806.12 +$3,443,139.99 4 4 1 2

ANSWER: Year Investment Operating CF Net CF Exchange rate Cash flows to parent PV of parent cash flows NPV 0 2 2 1,100 $1,818,181.82 $1,818,181.82 $1,818,181.82 2 7 7 1,200 $5,833,333.33 $4,568,355.65 +$2,750,173.83

A situation where the funds are blocked and the won is expected to depreciate reduces the NPV by $692,966.16.