End of year 0 1 2 3 4 5 6 7 8 9 10 Cash flow in Sfr 337 357 379 401

End of year 0 1 2 3 4 5 6 7 8 9 10 cash flow in sfr

This preview shows page 41 - 43 out of 43 pages.

41 Example 3 Wekeza Company in Tanzania is considering investing in Malawi. The investment would involve a current outlay of Malawian Kwacha (MKW) 8,800,000 on capital equipment and MKW 2,000,000 on working capital. The corporate tax rate in Tanzania is 30% and that of Malawi is 40%. There is no withholding tax for amount repatriated from Malawi to Tanzania.The project is expected to last for three years and all initial investments including the working capital will be incurred and paid for in December 2015. The revenues and cost for the projects are as provided in the table below: (Figures in “000” MKW) Year Revenue Variable Costs Fixed Costs 2016 47,500 15,000 11,000 2017 49,000 16,000 11,000 2018 34,200 12,800 11,000 Fixed costs include an annual charge of MKW 6,000,000 for depreciation. At the end of 2018 the working capital investment would be recovered and the net realizable value of the End of year 0 1 2 3 4 5 6 7 8 9 10 Cash flow in Sfr “mil” (20) 3.18 3.37 3.57 3.79 4.01 4.26 4.51 4.78 5.07 5.37 Expected Future spot rate 1.35 1.37 1.38 1.40 1.41 1.43 1.44 1.46 1.47 1.49 1.50 Cash flow in $ “mil” (14.81) 2.32 2.44 2.55 2.69 2.80 2.96 3.09 3.25 3.40 3.58 Discounting factor at 8% 1 0.93 0.86 0.79 0.74 0.68 0.63 0.58 0.54 0.50 0.46 PV in $ “mil” (14.81) 2.16 2.10 2.01 1.99 1.90 1.86 1.79 1.76 1.70 1.65 NPV = (2.16+2.10+2.01+1.99+1.90+1.86+1.79+1.70+1.65) 14.81 NPV = 18.92 14.89 NPV = US$ 4.11 Decision: The project has a positive NPVs it is therefore economically valuable. It should be accepted. The US Company should accept the project in Switzerland.
Image of page 41
42 equipment is estimated at MKW 9,000,000 Annual inflation is running at 7%. The current spot rate is MKW 20/TShs. The company requires a 10% return on any foreign investment. REQUIRED: As a hired consultant in Tanzania, evaluate the viability of the project. ADJUSTED PRESENT VALUE METHOD (APV) The adjusted present value method is the variation to the NPV method. It allows different component of projects cash flow to be discounted separately. This allows the required flexibility to be accommodated in the analysis of the foreign project. The method uses different discount rates for different. Segments of the total cash flow depending on the degree of certainty attached with each cash flow. i.e. the degree of risk. Operating cash flows are being viewed as more risk. They are therefore discounted at a higher discount rate. (The cost of equity) Financing cash flows are viewed as being less risk. They are therefore discounted at a lower discount rate (The cost of debt). The adjusted present value of a project is given by the following formula. APV = Sum CoEt + Sum KdDTC Initial cash investment (1+k) t (1+kd) t Where: CoEt = After Tax operating cash flows in period t K* = The required rate of return in the absence of (average of all equity financing) D = Value of debt financing sustainable by the project. Kd = Cost of debt financing. Tc = Corporate tax rate. APV = Present value of operating cash flow + Present value of interest tax shield + Present value of interest subsidies Present value of initial investment.
Image of page 42
43
Image of page 43

You've reached the end of your free preview.

Want to read all 43 pages?

  • Left Quote Icon

    Student Picture

  • Left Quote Icon

    Student Picture

  • Left Quote Icon

    Student Picture