Exam 18: International Capital Budgeting

Tiger Towers,Inc.is considering an expansion of their existing business,student apartments.The new project will be built on some vacant land that the firm has just contracted to buy.The land cost $1,000,000 and the payment is due today.Construction of a 20-unit office building will cost $3 million; this expense will be depreciated straight-line over 30 years to zero salvage value; the pretax value of the land and building in year 30 will be $18,000,000.The $3,000,000 construction cost is to be paid today.The project will not change the risk level of the firm.The firm will lease 20 office suites at $20,000 per suite per year; payment is due at the start of the year; occupancy will begin in one year.Variable cost is $3,500 per suite.Fixed costs,excluding depreciation,are $75,000 per year.The project will require a $10,000 investment in net working capital. $r \text { debt }$ = 10.0% $r \text { WACC }$ = 11.20% $r \text { asset }$ = 15.0% tax rate = 34% $\frac { D } { E }$ = 3 $r _ { \text {equity } }$ = 24.9% $r \text { free }$ = 2% What is the unlevered after-tax incremental cash flow for year 2?

Consider a project of the Cornell Haul Moving Company,the timing and size of the incremental after-tax cash flows (for an all-equity firm)are shown below in millions: The firm's tax rate is 34 percent; the firm's bonds trade with a yield to maturity of 8 percent; the current and target debt-equity ratio is 3; if the firm were financed entirely with equity,the required return would be 10 percent. What is the levered after-tax incremental cash flow for year 2?

Your firm's existing bonds trade with a yield to maturity of eight percent.The state of Missouri has offered to loan your firm $10,000,000 at zero percent for five years.Repayment will be of the form of $2,000,000 per year for five years; the first payment is due in one year. What is the value of this offer?

Consider the following international investment opportunity.It involves a gold mine that can be opened at a cost,then produces a positive cash flow,but then requires environmental clean-up. The current exchange rate is $1.60 = €1.00.The inflation rate in the U.S.is 6 percent and in the euro zone 2 percent.The appropriate cost of capital to a U.S.-based firm for a domestic project of this risk is 8 percent. Find the dollar cash flows to compute the dollar-denominated NPV of this project.

Today is January 1,2009.The state of Iowa has offered your firm a subsidized loan.It will be in the amount of $10,000,000 at an interest rate of 5 percent and have ANNUAL (amortizing)payments over 3 years.The first payment is due today and your taxes are due January 1 of each year on the previous year's income.The yield to maturity on your firm's existing debt is 8 percent.What is the APV of this subsidized loan? If you rounded in your intermediate steps,the answer may be slightly different from what you got.Choose the closest.

A French firm is considering a one-year investment in the United Kingdom with a pound-denominated rate of return of i_£ = 15%.The firm's local cost of capital is i_€ = 10%.The project costs £1,000 and will return £1,150 at the end of one year.The current exchange rate is €2.00 = £1.00. Suppose that the bank of England is considering either tightening or loosening its monetary policy.It is widely believed that in one year there are only two possibilities: S₁ (€/£)= €2.20 per £ S₁ (€/£)= €1.80 per £ Following revaluation,the exchange rate is expected to remain steady for at least another year. Find the IRR in euro for the French firm if they wait one year to undertake the project after the exchange rate rises to S₁(€/£)= €2.20 per £.

Perhaps the most important decisions that confront the financial manager are

Consider the following international investment opportunity: The current exchange rate is $1.60 = €1.00.The inflation rate in the U.S.is 3 percent and in the euro zone 2 percent.The appropriate cost of capital to a U.S.-based firm for a domestic project of this risk is 8 percent. Find the dollar cash flows to compute the dollar-denominated NPV of this project.

Consider a project of the Cornell Haul Moving Company,the timing and size of the incremental after-tax cash flows (for an all-equity firm)are shown below in millions: The firm's tax rate is 34 percent; the firm's bonds trade with a yield to maturity of 8 percent; the current and target debt-equity ratio is 3; if the firm were financed entirely with equity,the required return would be 10 percent. What is the levered after-tax incremental cash flow for year 4?

i = r_debt = 10% OCF₀ = −$100,000 K_u = r_assets = 15% OCF_1-4 = $39,800 = 25,000 × ($5 − $3)× (1 − 0.34)+ $20,000 × 0.34 K_l = r_equity = 24.9% OCF₅ = $43,100 = $39,800 + $5,000 × (1 − 0.34)K = r_WACC = 11.20% Tax rate = 34% Debt-to-equity ratio = 3 Risk-free rate = 2% The 5-year project requires equipment that costs $100,000.If undertaken,the shareholders will contribute $25,000 cash and borrow $75,000 with an interest-only loan with a maturity of 5 years and annual interest payments.The equipment will be depreciated straight-line to zero over the 5-year life of the project.There will be a pre-tax salvage value of $5,000.There are no other start-up costs at year 0.During years 1 through 5,the firm will sell 25,000 units of product at $5; variable costs are $3; there are no fixed costs. What is the NPV of the project using the WACC methodology?

The Strik-it-Rich Gold Mining Company is contemplating expanding its operations.To do so it will need to purchase land that its geologists believe is rich in gold.Strik-it-Rich's management believes that the expansion will allow it to mine and sell an additional 2,000 troy ounces of gold per year.The expansion,including the cost of the land,will cost $500,000.The current price of gold bullion is $425 per ounce and one-year gold futures are trading at $450.50 = $425 × (1.06).Extraction costs are $375 per ounce.The firm's cost of capital is 10 percent. Strik-it-Rich's management is,however,concerned with the possibility that large sales of gold reserves by Russia and the United Kingdom will drive the price of gold down to $390 for the foreseeable future.On the other hand,management believes there is some possibility that the world will soon return to a gold reserve international monetary system.In the latter event,the price of gold would increase to at least $460 per ounce.The course of the future price of gold bullion should become clear within a year.Strik-it-Rich can postpone the expansion for a year by buying a purchase option on the land for $25,000. Compute the NPV at the two possible prices of gold.

The firm's tax rate is 34 percent.The firm's pre-tax cost of debt is 8 percent; the firm's debt-to-equity ratio is 3; the risk-free rate is 3 percent; the beta of the firm's common stock is 1.5; the market risk premium is 9 percent.Calculate the weighted average cost of capital.

In the APV model

A French firm is considering a one-year investment in the United Kingdom with a pound-denominated rate of return of i_£ = 15%.The firm's local cost of capital is i_€ = 10%.The project costs £1,000 and will return £1,150 at the end of one year.The current exchange rate is €2.00 = £1.00. Suppose that the bank of England is considering either tightening or loosening its monetary policy.It is widely believed that in one year there are only two possibilities: S₁ (€/£)= €2.20 per £ S₁ (€/£)= €1.80 per £ Following revaluation,the exchange rate is expected to remain steady for at least another year. Using the notion of a hedge ratio,make a recommendation vis-à-vis how to undertake the project today without "buying" the option.

Given the following information for a levered and unlevered firm,calculate the difference in the cash flow available to investors.Assume the corporate tax rate is 40 percent. (Hint: Calculate the tax savings arising from the tax deductibility of interest payments). Levered Unlevered Reverue \ 250 \ 250 Operating cost -\ 100 -\ 100 Interest expense -\ 20 \ 0

An American Hedge Fund is considering a one-year investment in an Italian government bond with a one-year maturity and a euro-denominated rate of return of i_€ = 5%.The bond costs €1,000 today and will return €1,050 at the end of one year without risk.The current exchange rate is €1.00 = $1.50.U.S.dollar-denominated government bonds currently have a yield to maturity of 4 percent.Suppose that the European Central Bank is considering either tightening or loosening its monetary policy.It is widely believed that in one year there are only two possibilities: S₁ ($/€)= €1.80 per € S₁ ($/€)= €1.40 per € Following revaluation,the exchange rate is expected to remain steady for at least another year. Find the IRR in dollars for the American firm if they wait one year to buy the bond after the exchange rate falls to S₁($/€)= $1.40 per €.Assume that i_€ doesn't change.

Consider the following international investment opportunity.It involves a gold mine that can be opened at a cost,then produces a positive cash flow,but then requires environmental clean-up. The current exchange rate is $1.60 = €1.00.The inflation rate in the U.S.is 6 percent and in the euro zone 2 percent.The appropriate cost of capital to a U.S.-based firm for a domestic project of this risk is 8 percent. What is the dollar-denominated IRR of this project?

A French firm is considering a one-year investment in the United Kingdom with a pound-denominated rate of return of i_£ = 15%.The firm's local cost of capital is i_€ = 10%.The project costs £1,000 and will return £1,150 at the end of one year.The current exchange rate is €2.00 = £1.00. Suppose that the bank of England is considering either tightening or loosening its monetary policy.It is widely believed that in one year there are only two possibilities: S₁ (€/£)= €2.20 per £ S₁ (€/£)= €1.80 per £ Following revaluation,the exchange rate is expected to remain steady for at least another year. Using your results to the last question,make a recommendation vis-à-vis when to undertake the project.

Capital budgeting analysis is very important,because it

Tiger Towers,Inc.is considering an expansion of their existing business,student apartments.The new project will be built on some vacant land that the firm has just contracted to buy.The land cost $1,000,000 and the payment is due today.Construction of a 20-unit office building will cost $3 million; this expense will be depreciated straight-line over 30 years to zero salvage value; the pretax value of the land and building in year 30 will be $18,000,000.The $3,000,000 construction cost is to be paid today.The project will not change the risk level of the firm.The firm will lease 20 office suites at $20,000 per suite per year; payment is due at the start of the year; occupancy will begin in one year.Variable cost is $3,500 per suite.Fixed costs,excluding depreciation,are $75,000 per year.The project will require a $10,000 investment in net working capital. $r \text { debt }$ = 10.0% $r \text { WACC }$ = 11.20% $r \text { asset }$ = 15.0% tax rate = 34% $\frac { D } { E }$ = 3 $r _ { \text {equity } }$ = 24.9% $r \text { free }$ = 2% Assume that the firm will partially finance the project with a $3,000,000 interest-only 30-year loan at 10.0 percent APR with annual payments. What is the levered after-tax incremental cash flow for year 30?