A US company is considering building a UK plant. What is the adjusted present va

Question

A US company is considering building a UK plant. What is the adjusted present value (APV)?

Step1. Calculate Present Value of After Tax Cash Flow

Step2. Present Value of Depreciation Tax Shields

Step3. PV of Concessionary Loan Payment

Step4. Benefit from concessionary loan

Step5. Interest tax shields

Step6. Calculate APV

Blow are the information provided:

1. Initial capital outlay: GBP 20 million on plant and machinery.

2. The plant will produce 60,000 items in year 1, and production will increase at 10% a year up to and including year 4. This is incremental sales.

3. The current price of the product is GBP 250 per item and this is expected to increase in line with inflation.

4. The current variable cost of production is GBP 140 per item and, again, this is expected to increase in line with inflation. Of this, GBP 30 per product is sourced from the Home company in America. A profit margin of 25% is made on these sales.

5. The expected inflation rate in the US and UK respectively are 3% and 5%.

6. The corporation tax rate is 40% in the UK and 35% in the US.

7. The project is assumed to have a beta of 1 and the real rate of interest is assumed to be approximately 1 % in both the US and the UK. A market risk premium of 8% can be applied.

8. Plant and machinery in the UK is assumed to be written down on a straight-line basis over 4 years with no residual value.

9. The current spot rate is USD/GBP =2.00.

10. If the real interest rate is 1%, then the risk-free rate is approximately 6%, and the cost of capital 14% in the UK

Explanation / Answer

To compute the Present value of the project we need to find the cash flow :

step 1: cash flow from the project :

Step 2:

to compute the Net present value :

Particulars & formula 0 1 2 3 4 Initial investment -20000000 Production 10% increasing 60000 66000 72600 79860 Sales unit price 250 262.5 275.625 289.40625 Sales Production * 250 & increases with inflation 15000000 17325000 20010375 23111983.13 Cost per unit inflation 140 147 154.35 162.0675 Cost including inflation 8400000 9702000 11205810 12942710.55 Gross profit 6600000 7623000 8804565 10169272.58 Depreciation staright line 20000000/4 5000000 5000000 5000000 5000000 EBIT 1600000 2623000 3804565 5169272.575 Tax at 40% 640000 1049200 1521826 2067709.03 Profit after tax 960000 1573800 2282739 3101563.545 Cash flow = profit + depreciation -20000000 5960000 6573800 7282739 8101563.545

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