A U.S.-based firm is considering a five- year project in Colombia. The following
ID: 2742882 • Letter: A
Question
A U.S.-based firm is considering a five- year project in Colombia. The following information is available
about the project:
Initial investment. The initial investment of USD 900,000 is used to purchase capital equipment. This
equipment will be depreciated straight line to zero. At the end of five years, the remaining equipment will
be sold for Colombian Peso (COP) 200,000,000.
Working capital. The investment in working capital is COP 220,000,000. There are no changes in
working capital until the end of the project when the full amount is recovered.
Units, price, and costs. The firm will produce 1,250 units of a product annually. The selling price is
expected to be COP 700000 in the first year. This price is expected to increase at a rate of 5 percent
annually. The direct expense per unit is expected to be COP 200000 in the first year. This is expected to
increase at a rate of 8 percent annually. Indirect expenses are expected to be COP 80,000,000 annually.
Taxes and miscellaneous. Colombian taxes on income and capital gains are 35 percent. There are no
additional withholding taxes. All cash flows are repatriated when generated, and there are no additional
U. S. taxes. The parity conditions are assumed to hold between Colombia and the United States. The
FINC 6367 – International finance Excel Homework Page 2
relevant inflation indexes indicate a rate of 3 percent for the United States and 8 percent for Colombia.
Spot USDCOP equals 3000. Brady’s USD denominated WACC is 12 percent.
a. Calculate COP cash flows.
b. What is the appropriate COP discount rate? Calculate the project NPV.
c. Use parity conditions to generate future spot rates. Calculate the project NPV in USD.
d. Calculate break- even units.
e. Now assume that the COP rate of annual depreciation doesn’t follow parity conditions.
What is the break- even rate of depreciation in COP? Assuming the USD inflation is
unchanged, what is the COP inflation rate consistent with this break- even depreciation?
Explanation / Answer
Answer
Answer (a) Calculate COP cash flows.
Figures in Colombian Peso (COP)
Year
Sales unit
Selling price per unit
Total Sales
Direct expense per unit
Total Direct Expesnes
Indirect expenses
Profit before tax
Profit after tax
A
B
C
D
E
F
G
A*B
A*D
C-E-F
G*(1-tax rate)
0
1
1250
700000
875000000
200000
250000000
80000000
545000000
354250000
2
1250
735000
918750000
216000
270000000
80000000
568750000
369687500
3
1250
771750
964687500
233280
291600000
80000000
593087500
385506875
4
1250
810337.5
1012921875
251942.4
314928000
80000000
617993875
401696018.8
5
1250
850854.4
1063567969
272097.792
340122240
80000000
643445729
418239723.7
Figures in Colombian Peso (COP)
Year
Profit after tax
Depreciation tax benefits
Initial investment
Salvage value
Working capital
Real Cash flow
A
B
C
D
E
A+B+C+D+E
As calculated in above table
((900000*3000)/5)*0.35
(900000*3000)
200000000*(1-0.35)
0
-2700000000
-220000000
-2920000000
1
354250000
189000000
543250000
2
369687500
189000000
558687500
3
385506875
189000000
574506875
4
401696018.8
189000000
590696018.8
5
418239723.7
189000000
130000000
220000000
957239723.7
Figures in Colombian Peso (COP)
Year
Sales unit
Selling price per unit
Total Sales
Direct expense per unit
Total Direct Expesnes
Indirect expenses
Profit before tax
Profit after tax
A
B
C
D
E
F
G
A*B
A*D
C-E-F
G*(1-tax rate)
0
1
1250
700000
875000000
200000
250000000
80000000
545000000
354250000
2
1250
735000
918750000
216000
270000000
80000000
568750000
369687500
3
1250
771750
964687500
233280
291600000
80000000
593087500
385506875
4
1250
810337.5
1012921875
251942.4
314928000
80000000
617993875
401696018.8
5
1250
850854.4
1063567969
272097.792
340122240
80000000
643445729
418239723.7
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