Dennison, Texas cell-phone giant Cellular Two is evaluating a proposal to manufa
ID: 2652817 • Letter: D
Question
Dennison, Texas cell-phone giant Cellular Two is evaluating a proposal to manufacture and sell digital phones in Great Britain. The project will require an initial investment of £200 million to acquire and recondition the manufacturing plant in Manchester where the phones will be produced. The project will generate expected future after-tax cash inflows of £60 million at the end of each year during a 3-year project life. At the end of three years the manufacturing facility will be sold to British Cellular, generating after-tax proceeds of £150 million. The spot exchange rate is $1.6000/£1. The risk-free interest rate in the United States is 1.25 percent per year. The pound-denominated risk-free rate in Great Britain is 2.75 percent per year. Assuming that Cellular Two’s overseas after-foreign-tax profits can be repatriated to the US without further tax liability and that Cellular Two has a 14 percent required return, determine the net present value for the project.
Explanation / Answer
the cost of the project= £ 200 million
the cash inflow= £ 60 million per year
the present value= 60 * 2.322= £139.32 Million
the resale value after 3 years is £ 150 Million, its present value at 14% discount is = £150*0.675= £101.25
the total cash inflow is = £139.32+ £101.25= £240.57
if you deposit in US $, you will get an interest of 1.25%.
your interest return will be= £2.5 M*3= £7.5 for 3 years
if you deposit in Britain you will get an interest of 2.75%.
your interest return will be= £200 million *2.75%= £5.5 per year
and for 3 years it is= £5.5 *3= £17.5 million
your NPV in pounds= £240.57- 200- 17.5= £23.07 millions
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