Brower, Inc. just constructed a manufacturing plant in Ghana. The construction c

Question

Brower, Inc. just constructed a manufacturing plant in Ghana. The construction cost 8.5 billion Ghanian cedi. Brower intends to leave the plant open for three years. During the three years of operation, cedi cash flows are expected to be 3 billion cedi, 3 billion cedi, and 2 billion cedi, respectively. Operating cash flows will begin one year from today and are remitted back to the parent at the end of each year. At the end of the third year, Brower expects to sell the plant for 4.5 billion cedi. Brower has a required rate of return of 17 percent. It currently takes 8,700 cedi to buy one U.S. dollar, and the cedi is expected to depreciate by 5 percent per year.

a. Determine the NPV for this project. Should Brower build the plant? DRAW A TIMELINE

b.How would your answer change if the value of the cedi was expected to appreciate by 5 percent per year over its current value of 8,700 cedis per U.S. dollar over the course of the three years? Should Brower construct the plant then? DRAW A TIMELINE

Explanation / Answer

Answer A:

Year                                                       0                            1                              2                              3

Investment                                        –8.5

Operating CF                                                                      3                              3                              2

Salvage Value                                                                                                                                    5

Net CF (cedi billions)                    –8.5                       3                              3                              7                             

Exchange rate                                  8,700                     9,135                     9,592                     10,071

Cash flows to parent                      –$977,011.5        $328,407.23        $312,760.63        $695,065.04

PV of parent cash flows                 –$977,011.5        $280,689.94        $228,475.88        $433,978.15

NPV = –$977,011.5+$280,689.94+$228,475.88+$433,978.15 = -$33,867.5

As the NPV is negative, the project should not be undertaken.

Answer B:

If the cedi was expected to appreciate by 5% per year:

Year                                                       0                            1                              2                              3

Investment                                        –8.5

Operating CF                                                                      3                              3                              2

Salvage Value                                                                                                                                    5

Net CF (cedi billions)                    –8.5                       3                              3                              7                             

Exchange rate                                  8,700                     8,265                     7,851.75               7,459.16

Cash flows to parent                      –$977,011.5        $382,080.4           $402,189.9           $282,238.5

PV of parent cash flows                 –$977,011.5        $326,564.5           $293,805.2           $176,221.4

NPV = –$977,011.5+$326,564.5+$293,805.2+$176,221.4 = -$180,420

As the NPV is negative in this scenario also, the project should not be undertaken.

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