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Principles of Corporate Finance (11th Edition) See this solution in the app

3 Bookmarks Show all steps:Chapter 27, Problem 20PS ON

Problem

Carpet Baggers, Inc., is proposing to construct a new bagging plant in a country in Europe. The two prime candidates are Germany and Switzerland. The forecasted cash flows from the proposed plants are as follows:

The spot exchange rate for euros is $1.3/€, while the rate for Swiss francs is SFr 1.5/$. The interest rate is 5% in the United States, 4% in Switzerland, and 6% in the euro countries. The financial manager has suggested that, if the cash flows were stated in dollars, a return in excess of 10% would be acceptable.

Should the company go ahead with either project? If it must choose between them, which should it take?

  C0 C1 C2 C3 C4 C5 C6 IRR(%)

Germany(millions of euros ) -60 +10 +15 +15 +20 +20 +20 18.8

Switzerland (millions of Swiss francs) -120 +20 +30 +30 +35 +35 +35 12.8

Step-by-step solution

Net present value (NPV) method is used to measure financial viability of a project. It compares, total cash inflows with total cash outflows at the investor expectation rate at the beginning of the project. Hence, if the net present value is positive project should accepted and vice-versa.

Comment

Calculate net present value for Germany cash flows using minimum required rate of return as shown below:

(€ in millions and $ in millions)

Year Cash flows in €

Cash flows in $ Present value factor @10%

Present value of cash flows

0 (€ 60) ($78.00) 1.0000 ($78.00)

         

Step 1 of 4

Step 2 of 4

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1 € 10 $12.88 0.9091 $11.71

         

2 € 15 $19.13 0.8264 $15.81

   

 

   

3 € 15 $18.95 0.7513 $14.24

   

 

   

4 € 20 $25.03 0.6830 $17.10

   

 

   

5 € 20 $24.80 0.6209 $15.40

   

 

   

6 € 20 $24.56 0.5645 $13.86

   

 

   

Net Present Value

$10.11

Therefore, Net present value in dollars is 10.11 million.

Comment

Calculate net present value for Switzerland cash flows using minimum required rate of return as shown below:

(Fr. in millions and $ in millions)

Step 3 of 4

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Year Cash flows in Fr.

Cash flows in $ Present value factor @10%

Present value of cash flows

0 Fr. 120 ($80.00) 1.0000 ($80.00)

         

1 Fr. 20 $13.46 0.9091 $12.24

         

2 Fr. 30 $20.39 0.8264 $16.85

   

 

   

3 Fr. 30 $20.58 0.7513 $15.46

   

 

   

4 Fr. 35 $24.24 0.6830 $16.56

   

 

   

5 Fr. 35 $24.48 0.6209 $15.20

   

 

   

6 Fr. 35 $24.71 0.5645 $13.95

   

 

   

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Net Present Value

$10.25

Therefore, Net present value in dollars is 10.25 million.

Comment

Since, both the plants have positive net present values, both can be accepted. If the company should choose one among them, Switzerland plat should be preferred as it has relatively higher net present value.

Comment

Step 4 of 4

2 0

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Chapter 27, Problem 20PS

Carpet Baggers, Inc., is proposing to construct a new bagging plant in a country in Europe. The two prime candidates are...

See solution

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