Calculate the NPV of the cash flows expected in 2006-2010 using only the 2005 Cost of Capital (don’t worry about increasing costs of capital).
Calculate the NPV of the cash flows using the CASH FLOW figures at the bottom of the spreadsheet, these are the future values cash inflows.
Is the NPV positive or negative? Should the project be accepted? Why or why not based on NPV?
Show your calculations
What would be some of questions you may ask regarding the economic assumptions made during your calculations of NPV and regarding the expansion effort?
Expansion is happening in Germany and Brazil, not just domestically; what kind of risks does global expansion pose? How might political unrest affect the company? What about cultural issues?
Year 2005 2006 2007 2008 2009 2010
T= 0 1 2 3 4 5
Risk Free Rate 2.25% 2.50% 2.75% 3.00% 3.25% 3.25%
Cost of Capital 6.00% 7.00% 8.00% 9.00% 10.00% 11.00%
(US$ millions, incremental)
Net Sales 30 35 40 45 50
Selling, General & Admin -20 -18 -15 -12 -12
Depreciation -10 -10 -10 -10 -10
Interest Expense -2 -2 -2 -2 -2
Income before Taxes -2 5 13 21 26
Income Taxes 1 -2 -5 -8 -10
Net Income -1 3 8 13 16
Capital Investment -50
Addback Noncash 10 10 10 10 10
Cash Flow -50 8.76 13.10 18.06 23.02 26.12
To calculate the NPV of the cash flows expected from 2006-2010 using the 2005 cost of capital, you need to discount each cash flow to its present value using the cost of capital for each respective year. Here are the steps to calculate the NPV:
Step 1: Determine the discount rate for each year. In this case, we will use the 2005 cost of capital for all years.
Discount rates:
- 2006: 6.00%
- 2007: 6.00%
- 2008: 6.00%
- 2009: 6.00%
- 2010: 6.00%
Step 2: Calculate the present value of each cash flow by dividing the cash flow in each year by (1 + discount rate)^number of periods.
Present value calculations:
- 2006: 8.76 / (1 + 6.00%)^1 = 8.28
- 2007: 13.10 / (1 + 6.00%)^2 = 11.90
- 2008: 18.06 / (1 + 6.00%)^3 = 15.83
- 2009: 23.02 / (1 + 6.00%)^4 = 19.87
- 2010: 26.12 / (1 + 6.00%)^5 = 20.43
Step 3: Calculate the NPV by summing up the present values of the cash flows and subtracting the initial investment.
NPV = Sum of present values - Initial investment
NPV = 8.28 + 11.90 + 15.83 + 19.87 + 20.43 - 50
NPV = 26.31 - 50
NPV = -23.69
The NPV is negative (-23.69). Based on NPV analysis, a negative value suggests that the project is not financially viable because the present value of future cash flows is less than the initial investment. Therefore, the project should not be accepted based on NPV.
Regarding the economic assumptions made during the calculations of NPV and the expansion effort, some potential questions to ask include:
1. Are the selected discount rates representative of the cost of capital for each respective year? The accuracy of NPV calculations heavily relies on the appropriateness of the discount rates used.
2. Have any potential inflation rates or currency exchange rate fluctuations been considered? These factors can impact the actual value of future cash flows and the cost of capital in different countries.
3. Has the timeframe for the projection of cash flows been appropriately chosen? It is important to consider the timing and accuracy of expected revenues and costs over the projected period.
For the expansion effort in Germany and Brazil, there are additional risks to consider:
1. What are the political risks involved in these countries? This could include factors such as changes in government policies, instability, or regulatory challenges that could affect the company's operations or profitability.
2. How might cultural differences impact business operations in these countries? Understanding and adapting to local customs, communication styles, and business practices can be crucial for success.
3. Are there any legal or regulatory challenges specific to doing business in Germany and Brazil? Compliance with local laws, licensing requirements, and intellectual property protection can vary across different jurisdictions.
Consider conducting further analysis and research to assess these risks and their potential impact on the expansion effort.