Wenceslas Refining Company. Privately owned Wenceslas Refining Company is consid

Question

Wenceslas Refining Company. Privately owned Wenceslas Refining Company is considering investing in the Czech Republic so as to have a refinery source closer to its European customers. The original investment in Czech korunas would amount to K250 million, or $5,000,000 at the current spot rate of K32.50/$, all in fixed assets, which will be depreciated over 10 years by the straight line method. An additional k100,000,000 will be needed for working capital. For capital budgeting purposes, Wenceslas assumes sale as a going concern at the end of the third year at a price, after all taxes, equal to the net book value of fixed assets alone (not including working capital). All free cash flow will be repatriated to the United States as soon as possible. In evaluating the venture, the U.S. dollar forecasts are shown in the table above. Variable manufacturing costs are expected to be 50% of sales. No additional funds need be invested in the U.S. subsidiary during the period under consideration. The Czech Republic imposes no restrictions on repatriation of any funds of any sort. The Czech corporate tax rate is 25% and the United States rate is 40%. Both countries allow a tax credit for taxes paid in other countries. Wenceslas uses 18% as its weighted average cost of capital, and its objective is to maximize present value. Is the investment attractive to Wenceslas Refining?

Assumptions 0 1 2 3 Original Investment (Czech korunas, K) 250,000,000 Spot Exchange Rate (K/$) 32.50 30.00 27.50 25.00 Unit Demand 700,000 900,000 1,000,000 Unit Sales Price $10.00 $10.30 $10.60 Fixed Cash Operating Expenses $1,000,000 $1,030,000 $1,060,000 Depreciation $500,000 $500,000 $500,000 Investment in Working Capital 100,000,000

Explanation / Answer

Answer:

NPV calculation based on above-mentioned assumptions:

working notes of the table

1. calculation of sales

a) for a 1st year= No of units in demand * exchange rate of year one*unit sales price

For example I st year=(10*700000*30)=210000000

similarly for all the two years calculated

b)variable cost= As given in the question it's 40% of sales

For Ist year=210000000*0.40=105000000

Similarly for all the two years calculated

c) Fixed cost is given in the question in the table above its just converted into the exchange rate

For Ist year=1000000*30=30000000

Similarly calculated for the rest of the years

d)Depreciation is also converted in the similar fashion which is given in the above mention table at the spot exchange rate for every year.

For Ist year=500000*30=15000000

de) At last present value is calculated by taking NPV formulae at WACC Or R of 18%

NPV= original investment at 0 year + Investment in working capital-(Preset value of cash flows for all the years ie net income/ (1+r)^n)

=250000000+100000000-(45000000/(1+0.18)^1+6404025/(1+0.18)^2+70125000/(1+0.18)^3

=+223191187

since NPV of the project is positive this investment is worthwhile.

(ends)

Assumptions 0 1 2 3 Original Investment (Czech korunas, K) 2500,00,000 Spot Exchange Rate (K/$) 32.5 30 27.5 25 Unit Demand 7,00,000 9,00,000 10,00,000 Unit Sales Price $10.00 $10.30 $10.60 Fixed Cash Operating Expenses $1,000,000 $1,030,000 $1,060,000 Depreciation $500,000 $500,000 $500,000 Investment in Working Capital 1000,00,000

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