Exhibit 14-1
Assume that Baps Corporation is considering the establishment of a subsidiary in Norway. The initial investment required by the parent is $5,000,000. If the project is undertaken, Baps would terminate the project after four years. Baps' cost of capital is 13%, and the project is of the same risk as Baps' existing projects. All cash flows generated from the project will be remitted to the parent at the end of each year. Listed below are the estimated cash flows the Norwegian subsidiary will generate over the project's lifetime in Norwegian kroner (NOK):
|
Year 1 |
Year 2 |
Year 3 |
Year 4 |
|
NOK10,000,000 |
NOK15,000,000 |
NOK17,000,000 |
NOK20,000,000 |
The current exchange rate of the Norwegian kroner is $.135. Baps' exchange rate forecast for the Norwegian kroner over the project's lifetime is listed below:
|
Year 1 |
Year 2 |
Year 3 |
Year 4 |
|
$.13 |
$.14 |
$.12 |
$.15 |
24. Refer to Exhibit 14-1. What is the net present value of the Norwegian project?
|
a. |
−$803,848. |
|
b. |
$5,803,848. |
|
c. |
$1,048,829. |
|
d. |
none of the above |
ANS: C
Solution:
|
|
Year 0 |
Year 1 |
Year 2 |
Year 3 |
Year 4 |
|
Cash flow to parent |
−$5,000,000 |
$1,300,000 |
$2,100,000 |
$2,040,000 |
$3,000,000 |
|
PV of parent cash flow |
|
1,150,442 |
1,644,608 |
1,413,822 |
1,839,956 |
|
Cumulative NPV |
|
−3,849,558 |
−2,204,950 |
−791,128 |
1,048,828 |
PTS: 1
25. Refer to Exhibit 14-1. Assume that NOK8,000,000 of the cash flow in year 4 represents the salvage value. Baps is not completely certain that the salvage value will be this amount and wishes to determine the break-even salvage value, which is $____.
|
a. |
510,088.04 |
|
b. |
1,710,088 |
|
c. |
1,040,000 |
|
d. |
none of the above |
ANS: D
|
SOLUTION: |
Even if there is no salvage value, the NPV would still be positive, as shown below: |
|
|
|
|
|
|
|
|
|
|
|
|
|
Year 0 |
Year 1 |
Year 2 |
Year 3 |
Year 4 |
|
Cash flow to parent |
−$5,000,000 |
$1,300,000 |
$2,100,000 |
$2,040,000 |
$1,800,000 |
|
PV of parent cash flow |
|
1,150,442 |
1,644,608 |
1,413,822 |
1,103,974 |
|
Cumulative NPV |
|
−3,849,558 |
−2,204,950 |
−791,128 |
312,846 |
PTS: 1
26. Refer to Exhibit 14-1. Baps is also uncertain regarding the cost of capital. Recently, Norway has been involved in some political turmoil. What is the net present value (NPV) of this project if a 16% cost of capital is used instead of 13%?
|
a. |
−$17,602.62. |
|
b. |
$8,000,000. |
|
c. |
$1,048,829. |
|
d. |
$645,147. |
ANS: D