XYZ Corporation, an Australian based carmaker, is considering an expansion into
ID: 2620280 • Letter: X
Question
XYZ Corporation, an Australian based carmaker, is considering an expansion into Asia after its expansion into the US last summer was highly successful. Currently, XYZ does export cars to Asia, but the increased demand raises the question of an expansion in Asia. XYZ is trying to decide whether to establish a car manufacturing plant and office in Japan where cars would be built and then sold across Asia.
All relevant data is given in the tables below. The cost of the expansion is Yen 80,000,000, which must be immediately expended. Moreover, XYZ would have to fund additional working capital of Yen 5,000,000 at the time of the expansion. Further investment in net working capital would be Yen 5,000,000, Yen 8,000,000, and Yen 10,000,000 in year 1, 2, and 3 respectively. If it builds the plant, XYZ will depreciate it at a rate of Yen 4,000,000 per year ( starting in year 1) and will have to fund additional capital expenditures of Yen 8,000,000 per year to maintain and improve the plant. Although the project is assumed to have an infinite life, cash-flows are only projected up to three years and the terminal value of the project is computed based on the year 3 free cash-flow (FCF) assuming a growth rate that equals the Japanese long-run GDP growth rate.
All taxes are paid in Japan in the year the income is earned. Tax treaties are in effect so that XYZ will have no tax obligations to the Australian Tax Office (ATO). The following information applies to the valuation.
Required:
A) Calculate the cost of capital, in Australia, for the project.
B) Calculate the forward exchange rates, F1(AUD/Yen) through F3(AUD/Yen), for the years 1, 2, and 3 based on the spot rate and the interest rates given in the question. (round to 5 decimal places)
C) Calculate the Free of Cash Flows of the project in Yen from year 1 to year 3.
D) What is the terminal value as of year 3? Use a perpetuity formula, the Free Cash Flows in Yen for year 3, and the Japanese growth rate assumption given in the question. Assume the appropriate discount rate is WACC.
E) Calculate the AUD value of FCF for the years 0, 1, 2 and 3 and the terminal value using the forward rates calculated in (b).
F) What is the NPV of the project from XYZ’s perceptive (in AUD)? Should XYZ expand into the Asian market?
Japan Australia 2.00%+' | 3.00%;JI+' 3.00%+' | 40.00%+' | Price Inflation + Annual return on government bonds@| Corporate tax rate + Equity market risk premium AUD Spot rate-S(AUD/Yen) Before tax cost of debt Debt-to-value ratio (D/V)+ Systematic risk (beta) Japanese long-run GDP growth rate-l WACC 4.00%+' |p 30.00%+' 6.00%+' I+' 0.01 5.00%+' |+' 1.2 3%+' 12.80%+'Explanation / Answer
Soln : A) We need to calculate the cost of capital WACC with the help of debt and equity.
Let's calculate the cost of equity, r using CAPM model with risk premium given as 6% in Aus. and risk free rate = 4%
beta = 1.2, r = 4 + 6* beta = 4+ 6*1.2 = 11.2%
Cost of debt, R = 5% ( before tax) & Tax rate = 30%
Also, Debt to Value = 0.5, Equity to Value = 1-0.5 = 0.5
WACC = (debt to value) * cost of debt * (1-tax rate) + (Equity to value) *r
WACC = 0.5 * 5*(1-0.3) + 11.2* 0.5 = 0.5 * 14.7 = 7.35%
B) Inflation rate in Japan, id = 2% , In AUS, = 3%
Spot rate , S = 0.01 AUD/Yen. Let F1, F2 & F3 be the forward exchange rate
Taking all assumptions of interest rate parity , we can use the formula:
F1 = S*(1+if)/(1+id) = 0.01 *(1.03/1.02) = 0.01009
F1 i.e exchange rate in 1st year = 0.01009 AUD/Yen
Now F2 can be calculated using same thing i.e. F2 = F1 *(1+if)/(1+id) = 0.01009*(1.03)/1.02) = 0.010197AUD/Yen
F3 = F2 *(1+if)/(1+id) = 0.010197*(1.03)/1.02) = 0.010297 AUD/Yen
C) There are no revenues given, we have taken all costing part and depreciation is also added in expenses and evaluate the value after taxes, please refer the table :
D) Now, FCF in year 3 = 13.20 million as calculated above. Growth rate = 3%
Terminal value at year 3 = Cash Flows in year 4/(WACC - growth rate) = 13.20 *(1.03) /(12.80%-3%)
TV = 138.73469 million yen
Year 0 1 2 3 cost of expansion(in mn) Yen 80.00 Additional WC 5.00 5.00 8.00 10.00 Annual expenses 8.00 8.00 8.00 Depreciation 4.00 4.00 4.00 Total 85.00 17.00 20.00 22.00 Tax @40% 34 6.8 8 8.8 FCF 51.00 10.20 12.00 13.20Related Questions
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