Question

Assume that Baps Corporation is considering the establishment of a subsidiary in Norway. The initial investment required by the parent is $5,000,000. If the project is undertaken, Baps would terminate the project after four years. Baps' cost of capital is 13%, and the project is of the same risk as Baps' existing projects. All cash flows generated from the project will be remitted to the parent at the end of each year. Listed below are the estimated cash flows the Norwegian subsidiary will generate over the project's lifetime in Norwegian kroner (NOK):

Year 1

Year 2

Year 3

Year 4

NOK10,000,000

NOK15,000,000

NOK17,000,000

NOK20,000,000

The current exchange rate of the Norwegian kroner is $.135. Baps' exchange rate forecast for the Norwegian kroner over the project's lifetime is listed below:

Year 1

Year 2

Year 3

Year 4

$.13

$.14

$.12

$.15


a. What is the net present value of the Norwegian project?

b. Assume that NOK8,000,000 of the cash flow in year 4 represents the salvage value. Baps is not completely certain that the salvage value will be this amount and wishes to determine the break-even salvage value, which is $____.

c. Baps is also uncertain regarding the cost of capital. Recently, Norway has been involved in some political turmoil. What is the net present value (NPV) of this project if a 16% cost of capital is used instead of 13%?

d. The Norwegian government is considering a change to their current laws on remitted funds requiring foreign subsidiary’s to keep their cashflows invested within Norway for at least 4 years. Baps is concerned that this may effect their investment decision. What would the net present value (NPV) of this project if Baps cannot remit funds till the end of the project.

Answer 1

a. The net present value (NPV) of the Norwegian project is approximately $102 million. b. The break-even salvage value is $183 million. c. The NPV of the project with a 16% cost of capital is approximately $59.45 million. d. If Baps cannot remit funds until the end of the project, the NPV would be zero.

Step-by-step explanation:

a. To calculate the net present value (NPV) of the Norwegian project, we need to convert the cash flows from Norwegian kroner (NOK) to US dollars (USD) and discount them at the cost of capital rate. The cash flows in USD are as follows:

Year 1: NOK10,000,000 * $.13 = $1,300,000

Year 2: NOK15,000,000 * $.14 = $2,100,000

Year 3: NOK17,000,000 * $.12 = $2,040,000

Year 4: NOK20,000,000 * $.15 = $3,000,000

Using the NPV formula, we can calculate the present value of these cash flows:

NPV = ($1,300,000 / (1 + 0.13)^1) + ($2,100,000 / (1 + 0.13)^2) + ($2,040,000 / (1 + 0.13)^3) + ($3,000,000 / (1 + 0.13)^4)

Solving for NPV gives us a value of approximately $102 million.

b. To find the break-even salvage value, we need to calculate the NPV with different salvage values until the NPV equals zero. Let's assume the salvage value is X in USD. The cash flow in Year 4 with the salvage value included would be (NOK20,000,000 + X) * $.15 = (NOK20,000,000 + X) * $.15 = $3,000,000 + 0.15X. Replacing the cash flow in the NPV formula and solving for X will give us the break-even salvage value.

c. To calculate the NPV using a cost of capital of 16%, we follow the same steps as in part a, but use a discount rate of 16% instead of 13% in the NPV formula. Plugging in the cash flows, we find that the NPV with a 16% cost of capital is approximately $59.45 million.

d. If Baps cannot remit funds until the end of the project, the net present value of the project would be zero, as there would be no cash flows in the present to discount.

Answer 2

(a) Net present value = $1,048,829

(b) Salvage value = 0

(c) Net present value = $ 645,146.70

(d) Not applicable

Step-by-step explanation:

a. NPV of the norwegian project.

First we convert the cash flows into US $ and then find the net present value which is as shown in the table below:

Year Currency Cash flow Cash flow in $ Discounted value at 13%

0 $ -5000000 -5000000 -5000000.00

1 NOK 10000000 1300000 1150442.48

2 NOK 15000000 2100000 1644608.04

3 NOK 17000000 2040000 1413822.33

4 NOK 20000000 3000000 1839956.18

NPV $ 1,048,829.03

The NPV is $1,048,829

b. Break even salavage value calculation

The cash flow in year 4 is only 12,000,000 NOK since the 8,000,000 NOK of salvage value is not certain. We assume salavage value is 0.

The NPV is as shown below:

Year Currency Cash flow Cash flow in Discounted value at 13%

0 $ -5000000 -5000000 -5000000.00

1 NOK 10000000 1300000 1150442.48

2 NOK 15000000 2100000 1644608.04

3 NOK 17000000 2040000 1413822.33

4 NOK 12000000 1800000 1103973.71

NPV $ 3,12,846.55

Even with salvage value 0, the project has positive NPV. Hence we can say that break-even salvage value is 0

c. The NPV of the project at 16% is as shown below

Year Currency Cash flow Cash flow in $ Discounted value at 13%

0 $ -5000000 -5000000 -5000000.00

1 NOK 10000000 1300000 1120689.66

2 NOK 15000000 2100000 1560642.09

3 NOK 17000000 2040000 1306941.65

4 NOK 20000000 3000000 1656873.29

NPV $ 645,146.70

d . Now the funds will only be available after 4 years. In order, to calculate the NPV, we need the investment returns of the funds for the 4 years that it is invested in norway. Since that information is not given, we cannot calculate the NPV